D-R12? 823 DEPRECIATION ACCOUNTING IN THE UN4IFORM CHART OF 1/2ACCOUNTS(U) NAVAL POSTGRADUATE SCHOOL MONTEREY CAC L GEORGE DEC 82

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THESIS

DEPRECIATION ACCOUNTING IN THEUNIFORM CHART OF ACCOUNTS

by -%1

Charles Lee George

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December 1982

Thesis Advisor: Shu S. Liao

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Master's Thesis;Depreciation Accounting in the Uniform Dembr18Chart of Accounts .PSOiwON.EORlumm

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Charles Lee George

9. PERFORMING OR1GANIZATION MNZM ANO ACRS 10SPOGAM EONE UNT.VE TAUISK

Naval Postgraduate SchoolMonterey, CA 93940

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1S. KEY 30505 (CIa"1140 an po.,r.. sideo ics ear me fgemett aSP &I** RVRW3

Health Care Hospital Cost AccountingHospital Financial ManagementDepreciation AccountingUniform Chart of Accounts

20. ASITACT (CORehe ON POWrne ede It .eeS mi600 M~.d D A? 55.* '"Mawe)

This paper examines depreciation's contribution to the totalcost of providing health care. In particular it analyzes thedepreciation method used to measure the consumption of health

4care resources, the validity of the depreciation process and6 .4 the subsequent allocation procedures. As defined by the Uniform

Chart of Accounts, the usefulness of depreciation in determiningthe total cost of providing health care is attenuated by the

fact that a major portion of a facility's capital assets are

DD I A11 1473 'NOV 63o oIevsois ODIOL 113T

1 gCUQJTV CLASSIFICATION OF T"08S PAOErm maSnm

20. (continued)

excluded from the depreciation process, the rate of depreciationunderstates the estimated useful service life of the assets,double counts certain expenses, and makes no provisions toperiodically evaluate and adjust the composite rate ofdepreciation.

Comparisons are made between depreciation accounting in themilitary health service system and the civilian health caresector. Issues raised with the implementation of depreciationaccounting within the Uniform Chart of Accounts are addressedand recommendations are made that may enhance the usefulness ofthe depreciation methodology.

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Approved for public release; distribution unlimited

Depreciation Accounting in theUniform Chart of Accounts

by

Charles Lee GeorgeLieutenant, Medical Service Corps, United States Navy

B.S., College of Charleston, 1978

Submitted in partial fulfillment of therequirements for the degree of

MASTER OF SCIENCE IN MANAGEMENT

from theNAVAL POSTGRADUATE SCHOOL

December 1982

Author: / - --,

Approved by: _ _ _ _ ___ _

Thesis Advisor

Chairman, Department of istrative Sciences

Dean of Information and Policy Sciences

3

ABSTRACT

--- This paper examines depreciation's contribution to the

total cost of providing health care. In particular it analyzes

the depreciation method used to measure the consumption of

health care resources, the validity of the depreciation pro-

cess and the subsequent allocation procedures. As defined by

the Uniform Chart of Accounts, the usefulness of depreciation

in determining the total cost of providing health care is at-

tenuated by the fact that a major portion of a facility's

capital assets are excluded from the depreciation process,

the rate of depreciation understates the estimated useful

service life of the assets, double counts certain expenses,

and makes no provisions to periodically evaluate and adjust

the composite rate of depreciation.

Comparisons are made between depreciation accounting in

the military health service system and the civilian health

care sector. Issues raised with the implementation of

depreciation accounting within the Uniform Chart of Accounts

are addressed and recommendations are made that may enhance

the usefulness of the depreciation methodology.

.....

TABLE OF CONTENTS

I. INTRODUCTION------------------------------------------ 7

A. BACKGROUND---------------------------------------- 7

B. PURPOSE OF THESIS-------------------------------- 9

C. RESEARCH METHODOLOGY----------------------------- 10

D. THESIS ORGANIZATION------------------------------ 10

II. DEPRECIATION METHODOLOGY----------------------------- 12

A. FACTORS AFFECTING DEPRECIATION------------------ 1

B. METHODS OF DEPRECIATION------------------------- 1

C. GENERAL PRICE LEVEL EFFECT ONDEPRECIATION EXPENSES---------------------------- 24

III. DEPRECIATION METHODOLOGY USED BY CIVILIANHOSPITALS AND BY THE MILITARY MEDICALDEPARTMENT-------------------------------------------- 27

A. INTRODUCTION------------------------------------- 27

B. DEPRECIATION METHODOLOGIES USED BYCIVILIAN HOSPITALS------------------------------- 28

C. DEPRECIATION EXPENSE UNDER THE UCA-------------- 31

D. PROPERTY SUBJECT TO DEPRECIATION---------------- 31

E. DEPRECIATION EXPENSE ALLOCATION----------------- 34

F. CONCLUSION--------------------------------------- 34

IV. A CRITICAL ANALYSIS OF UCA DEPRECIATIONMETHODOLOGY AND RECOMMENDATIONS---------------------- 36

A. INTRODUCTION------------------------------------- 36

B. ASSUMPTIONS UNDERLYING THE UCA

DEPRECIATION METHODOLOGY------------------------- 37

C. UNIFORM CHART OF ACCOUNT'S DEPRECIATION:IS IT SYSTEMATIC AND REASONABLE?---------------- 41

5

D. DOES THE CURRENT UCA METHOD OF DEPRECIATIONALLOW MEANINGFUL COST COMPARABILITY AMONGMILITARY MEDICAL TREATMENT FACILITIES ANDWITH THE CIVILIAN HEALTH SECTOR?------------------ 47

E. IS THE UCA. DEPRECIATION REQUIREMENT SORESTRICTIVE AS TO MINIMIZE THE EFFECT OFDEPRECIATION ON THE TOTAL COST OFPATIENT CARE--------------------------------------- 51

F. CAN DEPRECIATION'S CONTRIBUTION TO TOTALCOST OF PATIENT CARE BE ISOLATED IN ORDERTHAT MANAGEMENT DECISIONS WILL NOT BEINFLUENCED BY SUNK COSTS?-------------------------- 53

G. CONCLUSION------------------------------------------ 54

V. RECOMMENDATIONS FOR CHANGES TO UCA

DEPRECIATION-------------------------------------------- 57

A. INTRODUCTION--------------------------------------- 57

B. RECOMMENDATIONS------------------------------------ 58

VI. SUMMARY AND CONCLUSION--------------------------------- 68

A. SUMMARY--------------------------------------------- 68

B. CONCLUSION------------------------------------------ 71

APPENDIX A: UNIFORM CHART OF ACCOUNTS FOR FIXEDMILITARY MEDICAL AND DENTAL TREATMENTFACILITI'FS-------------------------------------- 74

APPENDIX B: STATISTICAL ANALYSIS OF THE UNIFORMCHART OF ACCOUNTS COMPOSITE RATE OFDEPRECIATION------------------------------------ 89

LIST OF REFERENCES-------------------------------------------- 99

INITIAL DISTRIBUTION LIST------------------------------------ 102

*66

I. INTRODUCTION

A. BACKGROUND

outlays for health care in the nation reached approximately

$192.4 billion for the calendar year 1978 (Ref. 1]. This

represented approximately 9.1% of the Gross National Product

and amounted to approximately $863 per capita expenditure

[Ref. 11. Since 1965 health care costs have grown at an

average of 12.2% per year while prices in the economy as a

whole have grown at a 9.0% annual rate. This imbalance has

given rise to several attempts to control hospital costs either

by fiat (Economic Stabilization Act) or through the enactment

of federal laws such as the Health Maintenance Organization

Act of 1973, P.L. 93-222 or the Nstional Health Planning Act

of 1974, P.L. 93-641. By the end of 1980 the cost of health

care is estimated to be approximately 10% of the Gross Na-

tional Product.

The Department of Defense has not escaped the effect that

rising costs have had on the delivery of health care. Donald

Rice (Ref. 2] has estimated that during the period of 1967

through 1978 health care costs were rising at a rate of 30%

per year. The effect of these escalating health care costs

became more acute as the post-Vietnam military budget was

reduced in size and the purchasing power of the dollar was

eroded by inflation and the significant increases in weapons

system and personnel cost.

7

UA

Anticipating the squeeze that would be placed on the

military health care dollar the Department of Defense, Office

of Management and Budget, and Department of Health, Education

and Welfare, acting on a presidential mandate, initiated a

joint study of the military health care system in 1973.

The study was concluded in 1975 and was generally compli-

mentary toward the military health service system (MHSS). Not

only did the study show that the MHSS provided a broad spec-

trum of medical services to more than nine million beneficiaries,

but it demonstrated that the MHSS was capable of responding to

a variety of military and civil emergencies. However, it did

conclude that a number of opportunities existed to improve the

effectiveness and efficiency of the MHSS while maintaining the

delivery of quality health care to eligible beneficiaries

[Ref. 3].

Of the nine major recommendations outlined, one poisted

the need for a uniform medical data system within the three

military services. This recommendation led to the develop-

ment of a Department of Defense Uniform Chart of Accounts (UCA)

[Ref. 4]. The UCA was designed to record accumulate and re-

port information regarding the expense and workload within

military treatment facilities as a means of determining the

total cost of treating a patient. Among the benefits that

are expected to accrue to the MHSS by using the UCA are:

(1) enhanced cost awareness, (2) cost effectiveness evalua-

4 tion, (3) more effective decision-making when cost or

8d..

performance is a factor, and (4) better comparison among

military medical facilities and with the civilian health

sector (Ref. 41.

Appendix A contains an expanded explanation of the Uni-

form Chart of Accounts. The UCA is composed of six operating

expense accounts, two intermediate and four final. It is the

intermediate Support Service account that is of particular

relevance to this thesis. It is within this account that the

depreciation expense associated with military medical facili-

ties capital assets are accumulated and eventually allocated

to other support and mission centers.

B. PURPOSE OF THE THESIS

The purpose of this thesis is to analyze the issues con-

-fronting asset depreciation in the Naval Health Service System

(NHSS).

1. Issues

a. Does the current UCA method recognize deprecia-

tion expenses in a systematic and rational manner?

b. Does the current UCA method of depreciation allow

meaningful cost comparability among military medical treat-

ment facilities and with the civilian health sector?

c. Is the UCA depreciation requirement so restric-

tive as to minimize the affect that depreciation has on the

total cost of patient cazq?

9

*" - .'i , . 2 2 :; '". -. .. i , •. ..

d. Can depreciation's contribution to the total cost

of patient care be isolated in order that management decisions

will not be unduly influenced by a sunk cost?

C. RESEARCH METHODOLOGY

Thesis research methodology included a literature search

to identify the types of depreciation commonly used in the

health care industry, and interviews with civilian and mili-

tary health care administrators to identify their views on

depreciation accounting and each associated facility's used

depreciation accounting. Military directives were reviewed to

determine the basis for depreciation accounting. Statistical

analysis of plant account records from selected Naval Regional

Medical Centers was done to determine whether the assets shared

common features such as service lives and similar populations.

D. THESIS ORGANIZATION

The remainder of the thesis will be arranged as follows:

Chapter Two will discuss two types of depreciation

employed by business and industry in the private sector:

Straight-line (to include unit and composite rates) and ac-

celerated depreciation. Examples of each depreciation pro-

cedure will be given along with a synopsis of depreciation

methods used by four civilian medical organizations.

Chapter Three will be a comparison and analysis of

depreciation methods used by civilian hospitals and in the

Uniform Chart of Accounts.

10

i1 m m ~''i l kt -i lnml h i . . ' '

*Chapter Four will be a critical analysis of UCA

* depreciation.

Chapter Five will contain recommendations for changes

to the UCA depreciation methodology.

Chapter Six will summarize and conclude the thesis.

a

11

I

II. DEPRECIATION METHODOLOGY

The comparability of depreciation expenses among military

medical treatment facilities and between military medical

treatment facilities and the civilian health care sector can

be greatly influenced by the method of depreciation chosen,

depreciable base used and the estimated useful life of the

assets involved. In order to adequately evaluate the issues

surrounding depreciation and the subsequent use of the computed

expense, an understanding of the effect different depreciation

methods have on cost allocation would be helpful.

Therefore, this chapter will be concerned with describing

the various methods of depreciation and the effect these

methods have on the allocation of an asset's cost. It will

cover factors affecting depreciation, as well as discuss the

accelerated and straight-line method of depreciation. An il-

lustration of the effect various depreciation methods have on

cost allocation will be given, as well as briefly discussing

the effect that changes in the general price level have on

depreciation expense. It will also discuss the depreciation

method used by the Civilian Health Sector.

A. FACTORS AFFECTING DEPRECIATION

Accounting for the consumption of long-lived assets under

the accrual basis of accounting is done through a process of

6 depreciation. Depreciation is an accounting procedure by

12

which the cost (less salvage value -if any) of fixed assets

are allocated to expenses over the estimated useful lives of

such assets in a systematic and rational manner; it is a

process of cost allocation, not valuation. [Ref. 51

The estimation of depreciation is dependent on three

variables: Service life, depreciation base, and method of

cost apportionment. The service life of an asset is the total

units of service expected to be derived from that asset

(Ref. 5]. Arriving at the total units of service involves

* choosing the appropriate unit in which service life is to be

measured and then estimating how many units of service are

embodied in each asset. This usually involves estimating the

causes of the decreases in asset service and can generally be

divided into two classes: physical causes and function/

economic causes. Decreased asset service brought about by

physical deterioration results largely from wear and deteriora-

tion over time. These physical forces terminate the useful-

ness of plant items by rendering them incapable of performing

the service for which they were intended and thus set maximum

limit on service life (Ref. 5]. Functional depreciation on

the other hand arises from obsolescence or inadequacy of the

asset to perform effectively. Obsolescence may arise when

there is no further demand for the product that the depre-

ciable asset produces, or the same function for substantially

less cost. Inadequacy on the other hand refers to the effect

that growth and changes in the scale of a facility's operations

13

have on the termination of the asset's service life [Ref. 6].

For example, an x-ray processor may be in sound condition, but

if greater processing capacity is required which cannot

economically be provided by modifying the current machine,

the old machine has become inadequate and its economic service

life to the hospital is ended. Generally, any asset is

inadequate whose capacity is such that it cannot be operated

with optimum results, or whose capacity does not or cannot

fit the requirements of the organization [Ref. 6].

The second variable that must be considered is that por-

tions of the depreciations base that should be charged against

revenue during its service life. The depreciable base should

include all normal expenditures of readying an asset for use

and should consider the salvage value that may be realized at

* the end of the asset's useful life. Frequently, depreciable

assets have little or no salvage value at the end of their

estimated useful life and, if immaterial, the amount(s) may

be ignored [Ref. 61.

B. METHODS OF DEPRECIATION

The goal of depreciation should be to provide a reason-

* able, consistent matching of revenue and expenses by systemat-

ically allocating the cost of the asset over its estimated

useful life [Ref. 71. The most commonly encountered methods

in hospital accounting that attempt to accomplish this alloca-

tion are: straight-line depreciation methods (unit and group)

and accelerated depreciation. These methods differ in that

14

depreciation under the unit straight-line and accelerated

methods is a function of time, whereas depreciation under

the group method is based on a weighted-average of the

service lives of the assets involved [Ref. 7].

1. Straight-line Depreciation

a. Unit straight-line: The distinguishing character-

istic of the unit straight-line method is that an equal por-

tion of an individual asset's acquisition cost is allocated

to each year of service life. The annual portion of the

depreciation expense is computed in the following manner:

Depreciation Expense Acquisition Cost - Salvage Value

Number of years in the service life

Another distinguishing feature of calculating depreciation

expense for a unit depreciation schedule is that the decrease

in assets useful life is constant over time. A principal

advantage of the unit method is that it is simple to apply

and it may result in a reasonably accurate measure of an

asset's use. On the other hand, the objections to the

straight-line method center around economic productivity and

income measurement. Part of the controversy is that a con-

stant depreciation charge for each operating period does not

reflect variations in the rate of asset use and may accentuate

fluctuations in net income. Another objection to this method

is that for a given asset producing relatively constant earn-

ings each period, the use of the straight-line method will

show an increasing rate of return on the unrecovered

15Io

investment during each period of service life. Furthermore,

a constant depreciation charge overstates an asset's economic

productivity by not considering the fact that productivity

declines sharply as the asset ages [Ref. 8].

b. Composite and group depreciation are forms of

straight-line depreciation that are used when an organization

finds it expedient to account for depreciation on a group

basis rather than as individual assets. The term composite

usually refers to a collection of dissimilar assets; while

group depreciation refers to depreciating a collection of

similar assets. In either case, they are processes of averag-

ing the service life of a number of property units and then

taking depreciation on the entire lot as if it were an operat-

ing unit. A distinguishing feature of a composite or group

depreciation rate is that once the rate is computed, it is

continued in use until there is a material change in either

the composition of the assets or in the assets service lives

[Ref. 9].

Basic assumptions underlying the use of a com-

posite or group depreciation method are:

(1) Assets are regularly retired near the endof their service lives.

(2) Assets are replaced with similar assets.

(3) Proceeds on retirement are approximatelyequal to the estimated salvage value [Ref. 91.

16o.

"" 2. Accelerated Methods of Depreciation

The assumption that plant assets yield either a greater

quantity of service or more valuable services in early years

of service life has led accountants to devise methods of de-

preciation that will result in large amounts of depreciation

being recognized in the early years of the asset's service

life, and smaller amounts in later years (See Figure 1)

[Ref. 91. There are a number of different approaches that

can be used to compute an accelerated depreciation rate.

Only three will be dealt with in this thesis. These methods

are: fixed percentage of declining balance, double-declining

balance, and the sum-of-the-years-digits.

a. Fixed-percentage-of-declining balance method

computes a percentage depreciation rate which when applied

to the book value of the asset at the beginning of each

period, will result in writing the asset down to its estimated

net salvage value. The computed depreciation rate is applied

on a consistently declining asset value. The amount of de-

preciation expense decreases each year. The formula for

computing the required rate is:

n~et Salvage Value

Depreciation Rate =1- bAcquisition Cost

n = years of service life

17

-

A net salvage value greater than

zero must be estimated.

Example: Asset acquisition cost is $15,000

Net salvage value is $1,500

Service life is 5 years

5 $1,500

Depreciation Rate =1- $15,000

= 1 - .63

= .37

b. Double-declining-balance method uses a rate that

is twice the straight-line method (Ref. 9]. For example, an

asset with a five year service life would have a double-

declining rate of 40%, computed as follows: 2/n where n

equals the asset's service life in years. The one limiting

factor is that the asset can not be depreciated below its

estimated net salvage value. Taking for example an asset

with an acquisition cost of $15,000, a salvage value of

$1,500 and a service life of 5 years, the double declining

rate would be 40%. The depreciation expense in Year 4 would

be $1,269 and the book value of the asset would be $1,944.

Therefore, in Year 5 the maximum depreciation that could be

taken would be $544, reducing the asset's book value to the

estimated net salvage value floor of $1,500.

c. Sum-of-the-years-digits method computes a decreas-

ing depreciation expense by a simple mathematical procedure

relating to arithmetic progression [Ref. 61. The sum of a

18

series of numbers representing the years of service life

becomes the denominator of the depreciation fraction for any

one year. The formula for determining the denominator of the

depreciation fraction for an asset with a 5 year service life

is: n(n + 1)/2, where n equals the service life in years-

5(5 + 1)/2 = 15. The number of years of the asset's esti-

mated service life is the numerator for the depreciation

fraction in the first year. In each succeeding year the

numerator is reduced by one, until in the last year the de-

preciation fraction becomes a reciprocal.

The depreciation expense for an asset with an

estimated service life of 5 years in the first year would be

5/15 of the depreciable base and in Year 5, 1/15 of the base

would be credited to the accumulated depreciation account.

Since the denominator is constant and the numerator declines

each year, the result is a decreasing depreciation charge.

Because the total of the numerators of the depreciation frac-

tion equals 1, 100% of the depreciable base will ultimately

be charged to expense [Ref. 7].

3. Comparison of Different Methods

Figure 1 and Tables 1, 2 and 3 illustrate the effect

that the foregoing depreciation methods have on the magni-

tude and timing of depreciation expense. Table 1 shows that

by using the straight-line method, each year of service life

absorbs an equal portion of the acquisition cost. The book

value at the end of the fifth year equals the estimated

salvage value.

19

- .!~ •....- . . . ... ... . .. , .

Figure 1K Graphic Uisplay

of the timing ofDepreciation ExpensesShown in Fiure 1

100 Straight-Line 100 Fixed Percentage

of a

Declining Balance

50 50

1 2 3 4 5 1 2 3 4 5

(A) (B)

100 100

Sum-Of-The Double-Declining

. Years Digits Balance

50 50

1 2 3 4 5 1 2 3 4 5

(C) (D)

20

Table 1

Asset: Blood Chemistry Auto Analyzer

Acquisition Cost: $200,000

Salvage Value: $ 10,000

Service Life: 4 years

Sum of Double Fixed %

Service Straight the Years Declining of Declining

Year Line Digits Balance Balance

1 Dpr Exp $ 38,000 $ 63,333 $ 80,000 $ 90,144

Book Vl $162,000 $136,667 $120,000 $109,856

2 Dpr Exp $ 38,000 $ 50,667 $ 48,000 $ 49,514

Book Vl $124,000 $ 86,000 $ 72,000 $ 60,342

3 Dpr Exp $ 38,000 $ 38,000 $ 28,800 $ 27,197

Book Vl $ 86,000 $ 48,000 $ 43,200 $ 33,145

4 Dpr Exp $ 38,000 $ 25,333 $ 17,280 $ 14,939

Book V1 $ 48,000 $ 22,667 $ 25,920 $ 18,206

5 Dpr Exp $ 38,000 $ 12,667 $ 10,368 $ 8,206

Book Vl $ 10,000 $ 10,000 $ 15,552 $ 10,000

a

21

..

Table 2

Composite Depreciation Methods

Acquisition Service = Depreciation

Asset Cost Life(Yrs) Expense

Surgical Instrument

Cabinet $ 1,331 20 $ 66

Electrosurgical

Apparatus $ 13,032 8 $ 1,629

Surgical Table

(Remote Control) $ 8,910 15 $ 594

Carniotomy Table $ 1,390 15 $ 93

Telemetry Monitor $ 5,100 7 $ 728

Physiological Sys

Monitor (ICU) $ 85,000 7 $ 12,143

Coloson - 53 Pediatric

Stretcher $ 4,242 15 283

Double Pedestal

Desk $ 1,003 20 50

Total $120,008 $ 15,586

Composite rate equals: $15,586/$120,008 = 12.9%

22

,4

Table 3

Group Depreciation, Methods

Asset Qtv Unit Cost Total Cost Serv Life

* . Wheeled Hospital

Stretcher 27 $2,500 $67,500 15

Under the group method this group of assets would contri-

bute $67,500/15 =$4,500 annually as a unit to depreciation

expense.

The composite depreciation rate is 12.9%, with a composite

life of 6.8 years. Therefore 12.9% of the total acquisition

cost of this dissimilar group of assets, or $15,586, will be

expensed each year so that in 6.8 years the accumulated de-

preciation amount will equal the composite book value amount.

23

The sum-of-the-years-digit method allocates a larger

portion of the assets acquisition cost to the early years of

service life. By the end of the fifth year the book value,

like the book value obtained by the straight-line method,

equals the estimated net salvage value.

Using the double-declining method (Table 1), a uniform

* rate is applied to the asset's current book value. Since

book value is always reduced by the preceding year's deprecia-

tion expense, the rate is applied to a constantly declining

book value. As previously mentioned, an asset can not be

depreciated below its estimated salvage value when using the

double-declining-balance method of depreciation.

Depreciation expense computed using the fixed-percent-

age-of-declining-balance method declines sharply after the

first year and decreases at a decreasing rate until at Year

Five the book value approximates the estimated net salvage

value. The sharp decline in the depreciation expense occurs

because the depreciation for each year after Year 1 is only

55% of the preceding year's expense.

C. GENERAL PRICE LEVEL EFFECT ON DEPRECIATION EXPENSES

In 1976 the American Hospital Association (AHA) recom-

mended formally adjusting the plant asset accounts to ieflect

7- the effects of inflation as measured by changes in the general

purchasing power of the dollar. As a means of adjusting the

plant assets account, the AHA suggested using the index of

I

" 2 4

general prices known as the Gross National Product Implicit

* Price Deflator that is published quarterly by the Bureau of

Labor Statistics (Ref. 8].

- - As an example of7 the procedure to adjust for inflation,

assuame that an asset purchased on 1 Jan 1980 at a cost of

$70,000 has estimated life of 5 years and a salvage value of

- . $10,000. The GNP Deflator on 1 January 1980 was 200 and on

31 December 1980 it was 212. The entries to record the price

level change:

General Journal

* .Major Moveable Equipment

Price Level Increment $4,500

Unrestricted Fund Balance

Price Level Reevaluation $4,500

To record general price level increase.

($75,000 x 212/200) = $79,500

Historical Cost = 75,000

Price Level Increase $ 4,500

Depreciation Expense - Price

Level Adjustment

Accumulated Depreciation

Major Moveable Equipment

II Price Level Adjustment $720

25

To record price level adjustment on major moveable

equipment depreciation.

($12,000 x 212/200) $12,720

Historical Dpr Expense = 12,000

Price Level Increase $ 720

Except for those companies that meet the requirements of

the Financial Accounting Standards Board (FASB) Statement 33,

entitled "Financial Reporting and Changing Prices," account-

ing for inflation has not gained the status of a generally

accepted accounting principle [Ref. 6]. The AHA's recommenda-

tion is only a partial approach to the problem of accounting

for the effects of inflation on hospital operations [Ref. 7].

-. However, its use, while not meeting all of the requirements

for a generally accepted accounting principle is suggested

as supplementary information to financial statements [Ref. 7].

2r26

e"

* III. DEPRECIATION METHODOLOGY USED BY CIVILIAN HOSPITALSAND THE MILITARY MEDICAL DEPARTMENTS

* A. INTRODUCTION

Depreciation accounting is a recent occurrence within

the military medical departments. It became an official part

of the accounting and reporting systems in 1979 with the

advent of the Uniform Chart of Accounts (UCA). The accumula-

tion of depreciation expenses is an attempt to account for

the cost of consumption of long-lived fixed assets as an

operating expense over the property's estimated useful life. 1

It is a part of a larger expense collecting system that is

designed to determine the total cost of patient care. The

intent being among other things, to foster an atmosphere of

cost awareness, enhance cost-effective decision making, make

coherent work counts and serve as a gauge by which to make

meaningful comparisons among military medical facilities and

the civilian health sector (Ref. 41.

Depreciation can have a substantial effect on the deter-

.4 mination of the total cost of patient care depending on such

factors as the method of allocation selected, depreciable

base used, and the useful life of the fixed asset. These

* factors can in turn influence the degree of comparability of

1 Fixed assets are defined as those long-lived propertyitems not intended for resale in the regular business of theenterprise. Building and equipment constitute a subclassof the fixed assets category (Ref. 151.

27

the UCA cost figures among the military medical facilities

and between the military and civilian health sectors.

In order to better understand the effect of depreciation

on the cost of patient care and its subsequent effect on

cost comparability, a description of the UCA depreciation

methodology would be helpful. Accordingly, this chapter will

be devoted to describing and analyzing the depreciation

methodology used by civilian hospitals and the methodology

used in the Uniform Chart of Accounts for Military Medical

Treatment Facilities. Depreciation as a cost center within

the Uniform Chart of Accounts will be described along with

the threshold dollar value and type of equipment that con-

tributes to depreciation expense. The basic assumptions

underlying the UCA methodology will be analyzed and an example

will be used to illustrate the procedures used to calculate

the annual UCA depreciation expense.

B. DEPRECIATION MFTHODOLOGIES USED BY CIVILIAN HOSPITALS

The choice of depreciation used by a civilian hospital

depends upon how the depreciation expense is to be used.

Interviews with four civilian hospital finance directors

revealed that depreciation was used to determine income,

rate setting, Third Party reimbursements, cash flow genera-

tion, and for funding of asset replacements. Finance

directors interviewed were from: Kaiser Foundation Health

Plan, Inc., Oakland, CA., Community Hospital of the Monterey

Peninsula, Monterey, CA., Grace Hospital Inc., Morgantown,

28

4l

N.C., and California Hospital Association, Sacramento, CA.

Kaiser Foundation Health Plan is a prepaid group medical

plan, the Community Hospital of the Monterey Peninsula and

Grace Hospital Inc., are not-for-profit community hospitals

while the California Hospital Association administers the

MediCare and MediCal programs in the State of California.

* Kaiser Foundation Health Plan uses either an accelerated

or straight-line depreciation method for any class of

* depreciable assets and either a composite or unit rate method

for moveable equipment (Ref. 10, 11]. Depreciation is used

for two purposes: (1) calculate reimbursement rates and (2)

generate cash flow to meet future capital requirements.

Reimbursement rates receive a portion of the depreciation

expenses based on guidelines set forth by the California

Hospital Association and other Third-Party Payees [Ref. 10].

Funds provided by depreciation help meet future construction

needs. According to Mr. Philip Beretta, Regional Controller

for the Northern Region of the Kaiser Foundation Health Plan,

Kaiser Foundation can borrow approximately 50% of the construc-

tion cost of a new facility. The other 50% must come from

earnings (Ref. 10]. The amount of earning to be generated

by prepaid dues is determined by estimating the total capital

* requirements for a ten year period, subtract funds provided

by depreciation and borrowings during the same period to

arrive at a dollar figure for prepaid dues.

296'

The Director of Finance at the Community Hospital of the

Monterey Peninsula [Ref. 12] uses straight-line depreciation

in accordance with the accounting policies of the California

Hospital Association. The resulting depreciation expense is

used to compute a reimbursement rate.

Grace Hospital Inc., of Morgantown, N.C. [Ref. 13] uses

straight-line depreciation for rate setting, third-party

reimbursement and for funding for the replacement of capital

assets. Grace Hospital Inc. sets aside funds in an amount

equal to the annual depreciation expense to be used to provide

for the replacement of capital assets.

The California Hospital Association stipulates that the

method of depreciation used by hospitals for reporting to the

Association's Health Facilities Commission must be straight-

line depreciation method for all assets purchased after June

30, 1974 [Ref. 14]. If hospitals in California use a dif-

ferent method for accounting purposes, all timing differences

created by the difference between accounting and reporting

must be reflected in reports to the Health Facilities

Commission. The corresponding depreciation figure(s) is/are

used in determining reimbursement rates [Ref. 14].

Grace Hospital Inc. [Ref. 13] uses straight-line deprecia-

* tion for rate setting, third-party reimbursement and for

funding of capital assets replacement.

In selecting a method of depreciation, each hospital first

decides the purpose for which depreciation will be used, then

30

the hospital selects the appropriate depreciation method.

Straight-line depreciation was generally selected for rate

setting and reimbursement. Accelerated depreciation was

generally selected for cash flow and tax purposes.

C. DEPRECIATION EXPENSE UNDER THE UCA

Depreciation expenses under the UCA are computed using a

form of depreciation similar to the composite rate methodology.

Essentially the UCA method considers all equipment to have a

useful service life of eight years and that all equipment

subject to depreciation is fully depreciated after eight

years [Ref. 4].

Basically, under the eight-year moving average the assign-

ment procedure consists of adding the current fiscal years'

purchases to the present totals. Then subtracting the oldest

years totals as well as the dollar value of equipment surveyed,

lost, or destroyed during the preceding year. The new total

in each category (Dental Care, All Other) is divided by eight.

The resulting figure is the current fiscal year's depreciation

expense that will be allocated to the operating expense ac-

counts on a quarterly basis [Ref. 4].

Table 4 is an example of the method used to determine

the annual depreciation expense under the UCA procedures.

D. PROPERTY SUBJECT TO DEPRECIATION

Under the Uniform Chart of Accounts (UCA), depreciable

properties will include only those cost associated with

31

Table 4

Value of Investment Equipment

compromising the depreciable

base - Fiscal Years 1972

through 1979: l,584,000

Investment Equipment

Purchased Fiscal Year 1980 750,000

t2,334,000

Less:

Investment Equipment

Transferred FY 1980 $50,000

Investment Equipment

Surveyed FY 1980 25,000

Modernization and or

Replacement Investment

Equipment Purchased

FY 1972 400,000 ( 475,000 )

Value of Investment Equipment

comprising the depreciable

base: FY1973 - 1980 l,859,000

Annual depreciation expense = $1,859,000 x .125 depreciation factor fl/8)

$ 232,375

Quarterly depreciation expense 58,094

32

Ug

modernization and replacement equipment. Any equipment less

than the investment equipment threshold value of $1,000 will

2not be depreciated. Equipment less than $1,000 will be

3* charged to the receiving cost center as an operating expense

[Ref. 4].

The only investment depreciation expense allocated to the

operating expense accounts are those expenses associated

with replacement and modernization equipment funded from the

Other Procurement Appropriation [Ref. 41. Specifically ex-

cluded from the depreciation process are expenses associated

with: (1) new and expanded facilities, (2) those items

classified as real property (elevators, environmental control

units, etc.), (3) War Readiness Reserves, (4) support of any

Program Element other than PEC 877110, "Care in Defense

Facilities," and (5) support of Special Programs, such as

vehicles, clinical investigations, drug abuse programs, and

alcohol abuse rehabilitation.

2lInvestment equipment is equipment that is long-lived(greater than one-year), repairable and has a dollar valuegreater than $1,000. After October 1980 the dollar valuefor Investment Equipment will increase to $3000.

3As defined by DODINST 6010.10M a cost center is adiscrete functional or organization subdivision of amilitary medical facility for which provisions are madeto accumulate and measure its expenses and determineits workload performance.

33

E. DEPRECIATION EXPENSE ALLOCATION

Distribution of the depreciation expenses between the

Inpatient and Ambulatory care accounts is to be based on the

average occupied bed days:

Average Daily Occupied Distribution PercentageBed Days Inpatient Ambulatory

Greater than 250 60% 40%

Between 50 and 250 50% 50%

Less than 50 40% 60%

Clinics -0- 100%

Once the distribution percentage between Inpatient and

Ambulatory accounts has been determined, a ratio of occupied

bed days for the inpatient account to the total number of

occupied bed days will determine how much of the depreciation

expense is to be allocated to the particular inpatient account.

Allocation of the depreciation expense to the Ambulatory Care

work centers is based on a ratio of ambulatory clinic visits

to the total number of visits to the medical treatment

facility [Ref. 4].

F. CONCLUSION

The depreciation methodologies used by civilian hospitals

vary according to the use for which a hospital accumulates

4 depreciation. Military hospitals choice of depreciation is

set by fiat.

Civilian hospitals initially decide the purpose for

accumulating depreciation and then selects the most appropriate

34

depreciation method. Straight-line depreciation is generally

selected for :ate setting and third-party reimbursements.

While "==zlerated depreciation is usually chosen for cash

flow purposes and tax avoidance.

The method used by military hospitals is established by

the Department of Defense and is essentially a composite rate

of depreciation with an useful life based on an eight-year

moving average. The UCA depreciation method is used primarily

in determining the full cost of patient care. Once computed,

depreciation expenses are allocated to the various Inpatient

Care and Ambulatory Care accounts based on the facility's

daily average occupied bed days. After determining the dis-

tribution percentage between the two categories of accounts,

distribution to individual accounts is done on a ratio of the

individual account's work units to the total work units for

the medical treatment facility.

35

4

IV. A CRITICAL ANALYSIS OF UCA DEPRECIATION METHODOLOGY ANDRECOMMENDATIONS

A. INTRODUCTION

As stated in Chanter One, the Uniform Chart of Accounts

was developed by the Department of Defense as a cost collec-

tion system designed to record, accumulate and report informa-

tion regarding the expense and workload within a military

treatment facility as a means of determining the total cost of

treating a patient [Ref. 4]. An integral part of the total

cost of providing health care is accounting for the consumption

of long-lived fixed assets used in the delivery of health care.

The accepted means of recognizing this consumption is through

depreciation. Depreciation is defined as a system of account-

ing whose purpose is to distribute the cost or other basic

value of tangible capital assets over the estimated useful

life of the unit in a systematic and reasonable manner

[Refs. 6, 211.

Accepting the foregoing definition, the UCA established

a system of depreciation that would account for the consump-

tion of long-lived assets and then allocate the consumption

based on a ratio of occupied bed days, in the case of Inpatient

Care, or a ratio of clinic visits for Ambulatory Care [Ref. 4].

Taking into consideration the UCA depreciation methodology

and its underlying assumptions, four issues are raised:

* (1) Does the current UCA method recognize depreciation expense

36

I1

in a systematic and reasonable manner? (2) Does the current

UCA method of depreciation allow meaningful cost comparability

among military medical treatment facilities and with the

*[ civilian health sector? (3) Is the UCA depreciation require-

ment so restrictive as to minimize the effect of depreciation

on the total cost of patient care? (4) Can depreciation's

contribution to the total cost of patient care be isolated so

that management decisions will not be influenced by sunk

costs? (5) Expense involving the purchase equipment in the

$1,000 to $2,999 range are double counted.

The purpose of this chapter is to analyze the underlying

assumptions regarding UCA depreciation and challenge the

foregoing issues as well as offer recommendations that may

enhance the value of depreciation accounting within the Uni-

form Chart of Accounts.

B. ASSUMPTIONS UNDERLYING THE UCA DEPRECIATION METHODOLOGY

The depreciation scheme used in the UCA is basically a

composite rate of depreciation whereby the rate has been set

by fiat at 12.5% [Ref. 4]. Assumptions that have to be made

for the eight-year (or 12.5%) moving average to give valid

depreciation information are: the useful life of the medical

equipment is normally distributed throughout the populationIiand has a mean life expectancy of eight years; retired assets

are replaced with assets having similar useful lives; there

will be no material change in the composition of assets; only

37

modernization and replacement equipment with a value above

the $1000 threshold contributes to the expense of providing

medical care in a military medical treatment facility [Ref. 4].

As a means of testing the validity of the assumption that

the average useful life of medical equipment is eight years

and is normally distributed throughout the equipment population,

a series of five random samples were drawn from equipment list

of seven Naval Regional Medical Centers (NRMC) and analyzed to

see if the eight-year mean useful service life was a reason-

able figure. Statistical tests were completed to see if the

individual samples were drawn at random, if they came from the

same population, and if the sample averages came from identical

populations. Appendix B outlines the methodology used to

determine the mean, standard deviation, confidence interval,

the results of the Runs Test for Randomness and the Kruskal-

Wallis One-Way Analysis of Variance. The results of the anal-

ysis supports the contention that while the equipment in use

* at the various NRMCs come from identical populations, the

* eight year useful life is too low. The range of sample

averages are:

Confidence Interval at 95%

Lower Limit Upper Limit

NRMC, Bethesda, Md 11.7 yrs 13.3 yrs

NRMC, Camp Lejuene, NC 11.5 yrs 13.5 yrs

NRMC, Charleston, SC 9.0 yrs 10.6 yrs

4 NRMC, San Diego, CA 10.6 yrs 12.4 yrs

38

NRMC, Camp Pendelton, CA 11.2 yrs 13.1 yrs

NRMC, Long Beach, CA 10.0 yrs 11.0 yrs

NRMC, Oakland, CA 11.0 yrs 12.6 yrs

Overall Confidence Interval 10.5 yrs 12.5 yrs

Intuitively, second and third assumptions are difficult

to accept. Saying that retired assets are replaced with assets

having similar useful lives and there will be no material

change in the composition of assets one would have to ignore

state-of-the-art changes in medical equipment. Plus, accept

the contention that military medicine is a static undertaking

that does not respond to innovation in health care.

The fourth assumption has the greatest impact on the amount

of depreciation expenses that will be allocated to the inpatient

and ambulatory care accounts. Considering only modernization

and replacement equipment as contributors to the expense of

providing medical care excludes a majority of a Naval Regional

Medical Center's capital assets. In order to evaluate the

impact of excluding real property and new and expanded

facilities on depreciation expenses, real property and equip-

K1O ment records from four Naval Regional Medical Centers,

Charleston, SC, Camp Lejeune, NC, Long Beach, CA, Bremerton,

WA were reviewed and compared with the depreciation expenses

reported under the UCA procedures for Fiscal Year 1980.

As can be seen from Table 5 the effect of excluding real

property and new equipment can have a substantial impact on

6 the amount of depreciation expenses that are allocated to the

39

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various medical care accounts. Several strong assumptions

were made regarding the depreciable base: no equipment in

service exceeds the composite service life in Column Five;

all of the property and equipment are used in support of

Program Element "Care in Defense Facilities," PEC 877110.

The effect that the foregoing assumptions have on the

overall amount of depreciation expense of course varies within

each facility. However, the value of the comparison is not

to show an absolute dollar variance. Rather it is to show

the magnitude of the variance. Excluding real property and

new or expanded facilities from depreciation results in a

variance in reported depreciation that ranges from $307,000

for NRMC Charleston, SC to around $2,700,000 for the new

facility at Bremerton, Washington. In Table 5, Real Property

was depreciated using a 40 year useful service life. The

category Real Property includes not only buildings with 40 year

estimated useful lives, but sidewalks, parking lots, ele-

vators and other items with estimated useful lives that range

from 12 to 25 years. However, in the final analysis the dif-

ference in depreciation expense using a composite life of 40

years and depreciating each item at its estimated service

lives was immaterial.

C. UNIFORM CHART OF ACCOUNT'S DEPRECIATION: IS ITSYSTEMATIC AND REASONABLE?

According to L. Van Seawell [Ref. 21] depreciation of

plant assets should be recognized by hospitals. The periodic

41

charge should be based upon a systematic and reasonable

allocation of the previously recorded acquisition costs of

such assets. Accepting this premise at face value gives

rise to a two part question about the current UCA depreciation

method. Is the UCA recognition of depreciation systematic and

reasonable?

Under the UCA depreciation is computed in a systematic

* manner. Guidelines are established to determine service life

of the assets to be depreciated, the depreciable base is

defined, and the method of allocating depreciation to the

operating expense accounts is outlined.

The reasonableness of the Uniform Chart of Accounts'

* depreciation can be questioned on several points: (1) exclud-

ing certain assets from depreciation understates the cost of

providing patient care, (2) the eight year service life under-

states the useful service life of the assets that are

depreciated, and (3) allocating depreciation from a common

cost pool disregards the fact that some clinical services are

more equipment intensive than others.

Under the Uniform Chart of Accounts, only modernization

and replacement equipment with a dollar value equal to or

greater than $1,000 will be depreciated [Ref. 41. Excluded

4 from this category of equipment are all buildings, land

improvements, furniture, new equipment and equipment with an

acquisition cost of under $1,000. Referring to Table 5, one

can gauge the effect that excluding real property, furniture

r42

and new equipment from the depreciation process has on the

annual depreciation expense. In the case of a new facility

-* . like the Naval Regional Medical Center, Bremerton, WA, the

foregoing exclusions can result in understating the annual

depreciation expense by about $2,600,000. The same exclusions

will understate depreciation expenses for an established

facility like Naval Regional Medical Center, Charleston, SC by

approximately $300,000.

Any process that ignores expenses ranging from $300,000

to $2,600,000 because of the source of funding [Ref. 4] used

to acquire the assets, or because of the assets classifica-

tion, appears to be unreasonable. If the purpose of account-

ing for depreciation within the UCA is to get a better picture

of the cost of providing medical care, the process should not

overlook assets that form the bulk of the cost of the medical

facility. Irrespective of how the assets were acquired or

what class of asset is involved, all assets are a cost to the

government and they are expenses attributable to providing

medical care. As such, they should be considered in account-

ing for the cost of providing medical care.

Another aspect of UCA depreciation that is open to question

is the validity of the standard eight year service life. As

indicated by Appendix B there is sufficient variation between

estimated service lives from the seven NRMC's sampled as to

suggest that a uniform depreciation rate does not accurately

4 represent how long individual Medical Centers can expect to

43

utilize their investment equipment. The eight year figure

understates the average estimated service life by a percent-

age that ranges from 13% to 35% for the Naval Regional Medical

Center Charleston, SC and from 46% to 69% for the Naval Re-

gional Medical Center, Camp Lejeune, NC. Considering the

range of the variation between the standard depreciation rate

and the various rates indicated by Appendix B, the accuracy of

determining the composite service life for each facility could

be improved if each facility computed individual composite rates

of depreciation.

However, data processing equipment obviates the need to

compute a composite rate of depreciation. NRMCs currently

possess sufficient data processing equipment to be able to

depreciate individual pieces of equipment on a straight-line

basis and circumvent the tedious manual task of trying to

accurately figure straight-line depreciation for a large

number of dissimilar assets. The necessary information is

maintained by each NRMC. Plant property records list the

item, acquisition cost, date the asset was placed in service,

and estimated service life, and the department to which the

asset is assigned [Ref. 22]. Using these data and with the

help of a computer, it becomes a minor task to write a program

or a subroutine to an existing program, that will compute and

total the depreciation expense. The convenience of using a

computer to figure depreciation expenses obviates the need

for simplicity in a manual system and bypasses the assumption

44

.4

that retired assets are replaced with assets having similar

costs and useful lives, events that rarely, if ever, occur.

The reasonableness of the depreciation allocation process

can be challenged on the grounds that it inequitably assigns

expenses to the various cost centers. All depreciation ex-

penses are assigned to a cost pool, then allocated on the

basis of a ratio of clinic visits in the case of ambulatory

care, or a ratio of occupied bed days for inpatient care.

Allocating depreciation on the basis of such ratios does not

take into account that certain clinical services are more

capital intensive than others [Refs. 19, 201. For example, a

Coronary Care Unit (CCU) will have more money invested in

equipment than will a more labor-intensive inpatient service

such as a Neurology Service [Refs. 15,16]. Under the UCA

procedures all inpatient accounts receive a proportional share

of equipment depreciation expenses irrespective of the amount

of equipment that the account owns. In effect, the heavy

investment of any service in equipment is distributed to other

services. Consequently, the cost of operating an equipment-

intensive service is understated while the cost of operating

the labor-intensive service is overstated. The same effect

is seen in allocating depreciation to the Ambulatory Services.

Those Ambulatory Services, such as a Primary Care Clinic,

that are labor-intensive receive a disproportion share of the

depreciation expense.

45

It would be more equitable and no more difficult to

charge depreciation expense on equipment to the using cost

center. Then only in those cases where a piece of equipment

is not readily identified to a particular cost center should

the corresponding depreciation expense be accumulated in a

common cost center and allocated to all cost centers on the

basis of occupied bed days or number of clinic visits [Refs.

24, 25].

A companion to the reasonableness issue is one that deals

with the double counting of certain UCA expenses. In partic-

ular the double counting of expenses associated with the pur-

chase of equipment in the $1,000 to $2,999 range. In the

absence of either increasing the UCA depreciation threshold

value to $3,000 or making year-end adjusting entries, double

counting of expenses associated with the purchase of equip-

ment whose acquisition cost ranges from $1,000 to $2,999 will

be a problem that will appear during Fiscal Year 1981 and

beyond.

Double counting expenses will occur because of the variance

in the way investment equipment is defined by the Resource

Management System and the Uniform Chart of Accounts. In Fiscal

Year (FY) 1981 the Resource Management System increased the

4 threshold value for Investment Equipment from $1,000 to $3,000

(Ref. 26]. However, the Uniform Chart of Accounts still main-

tains the threshold value for Investment Equipment at $1,000

4d [Ref. 4]. Without adjusting the UCA threshold value it will

46

be possible to expense the cost of a piece of equipment in

-_ the year of acquisition and then turn around and depreciate

it over an eight year period beginning in the following fiscal

year.

Under the Resource Management System (RMS) equipment cost-

ing less than $3,000 will be purchased with Operations andMaintenance (O&M) funds [Ref. 26]. The purchase of equipment

with O&M funds is subsequently reported on the Functional

Category/Expense Element Report, NAVCOMP 2171, as an expense

[Ref. 26]. The Uniform Chart of Accounts in turn allocates

the expense reported on the NAVCOMP 2171 to the appropriate

UCA operating expense account. However, since the equipment

depreciation threshold value under the UCA is still $1,000

[Ref. 4], there is a potential for either overstating deprecia-

tion expenses by 12.5% for eight years, or overstating

operating expenses for the cost center by an amount equal to

the total cost of equipment purchased in the $1,000 to $2,999

range in the year of acquisition.

D. DOES THE CURRENT UCA METHOD OF DEPRECIATION ALLOW MEANINGFULCOST COMPARABILITY AMONG MILITARY MEDICAL TREATMENTFACILITIES AND WITH THE CIVILIAN HEALTH SECTOR?

Comparability among military medical treatment facilities

is assured by the fact that all of the military facilities are

governed by the same Department of Defense directives and are

required to account for depreciation in the same way, follow-

ing identical allocation procedures [Ref. 4].

47

Comparability between military medical treatment facili-

ties and civilian health care centers is another matter. Where

the uniformity within the Department of Defense assures that

all military medical treatment facilities follow the same

guidelines in computing and allocating depreciation the lack

of uniformity between the military and civilian health sectors

in the use of depreciation accounting impedes cost comparability

between these two sectors. Table 6 illustrates the dissimilar-

ities between the UCA depreciation methodology and the methods

commonly used in the civilian health care sector.

The driving force behind a civilian medical facility's

choice of a depreciation method is the purpose to which the

resulting expense will be used. For example, if the purpose

of depreciation is to generate cash flow, accelerated deprecia-

tion would be used [Ref. 10]. However, if the purpose for

accumulating depreciation is to determine a contractural

reimbursement rate, straight-line depreciation would be used

(Ref. 28].

Table 6 illustrates that there is no uniformity in the

types of depreciation used by the civilian health care sector,

with the choice of depreciation relying on the purpose to

which the calculated expenses will be used. Lacking uniformity,

cost comparison between military and civilian medical facil-

ities is meaningless when the final cost figures include

depreciation expenses. Depending on the method used, the

estimated useful life, class of asset depreciated, and the

48

Table 6

Dissimilarites between theUniform Chart of AccountsMethod of Depreciation andDepreciation Methods used inthe Civilian Health Sector

Item Uniform Chart of Accounts 1 Civilian Health Sector 2

Threshold Value for $1,000 Variable. Ranges fromAsset Capitalization $25 to $25,000

dependingon the class of assetbeing capitalized.

Class of Asset Modernization and replace- Generally any assetDepreciated ment equipment only. that exceeds the

Real property capitalizationnew and expanded threshold value and has anfacilities are not expected useful lifedepreciated. greater than one year.

Depreciation Method Modified Composite Rate. Generally straight-lineComposite rate of depre- depreciation is used forciation has been estab- reimbursement rate settinglished by fiat at 12.5% and accelerated depreci-(eight year useful life). ation is used for account-

ing purposes.

Method of Based on a ratio occupied Assigns direct costAllocation of bed days or a ratio of depreciation to specific

clinic visits. Does not cost centers. Allocatescharge depreciation indirect cost based on thedirectly to the using value of equipment or thecost center. square footage of building

occupied.

Reason(s) for Compute full cost of Rate setting, cashaccounting for patient care flow generation and fund-depreciation ing for depreciation 3

1 Reference 4.

2 References 10, 12, 13, 14, 28.

3 Funding of depreciation refers to the process by which cash resourcesare set aside periodically and accumulated for the purpose of financingthe renewal or replacement of plant assets. (Ref. 21)

4

49

NAVAL REGIONAL MEDICAL CENTERCamp

Lejuene Charleston Long Beach BremertonINPATIENT CARE

Total Occupied Bed Days1 45,937 50,697 36,642 23,678

Fourth Quarter FY801

Cost Year-To-Date $8,035,100 $9,924,728 $9,955,199 $5,230,337

Figure 5, Page 38Variance multiplied by 0.5 363,824 150,000 527,201 1,317,354

Adjusted Fourth QuarterFY80 Cost Year-To-Date $8,398,934 $10,074,728 $10,462,400 $6,547,691

Approximate cost peroccupied bed day (Fourth QtrFY80 Cost YTD divided byOccupied Bed Days) $175 $196 $272 $221

Adjusted Cost Per Occupied(Adjusted Fourt Qtr FY80 Costdivided by Total Occupied BedDays) $183 $199 $286 $276Percent Increase Attributedto Depreciation 4.5% 1.5% 5.0% 25.0%

AMBULATORY CARE

Total Clinic Visits2 332,331 401,787 340,082 183,652

Total Ambulatory CareExpenses2 $7,444,632 $8,404,753 $10,108,776 $4,584,197

Figure 5, Page 38Variance multiplied by 0.5 363,834 150,000 527,201 1,217,354

Adjusted Total Expenses $7,808,466 $8,554,753 $10,635,977 $5,891,551

Average Cost Per Visit(Total Expenses/Total Visits) $21.89 $20.92 $30.41 $24.96

- Average Adjusted Cost PerVisit (Adjusted TotalExpenses/Total Visits $22.94 $21.29 $31.46 $32.12

Percent Increase Attributedto Depreciation 4.8% 1.8% 5.2% 28.7%

Table 7Adjusted Average Cost Per Occupied Bed Day

and Per Ambulatory Care Vist

1 Reference 292 Reference 30 50

I.

reason for accounting for depreciation, a medical facility can

adjust the total cost of health care delivery. Taking the

four NRMCs listed in Table 7 as representative of the degree

* . to which a Military Treatment Facility could influence the

recorded cost of health care delivery, it can be seen that by

carefully selecting the method of depreciation, estimated

useful life, and the depreciable base a Military Treatment

Facility can vary its reported cost by as much as 28%. Mean-

while civilian hospitals can alter their depreciation expenses

by choosing from among the various depreciation methods.

Their choice of which depreciation method to use would depend

upon the purpose for which the depreciation expenses are to be

used. Generally, civilian hospitals tend to select straight-

line depreciation for rate setting and reimbursements while

selecting accelerated depreciation for cash flow and tax

purposes (Refs. 7, 10, 11, 12, 13, 14].

E. IS THE UCA DEPRECIATION REQUIREMENT SO RESTRICTIVE AS TOMINIMIZE THE EFFECT OF DEPRECIATION ON THE TOTAL COST OFPATIENT CARE?

Iterating what has been said before, depreciation require-

* - ments minimize the effect of depreciation on the total cost of

patient care; ignoring depreciation expenses ranging from

$300,000 to $2,600,000 annually certainly decreases the value

of the depreciation process in the cost collection system.

Using the summary data in Table 5, and data from Reference 28

and 29, Table 8 illustrates the effect of excluding all but

51

Table 8

Depreciation's Contributionto the Total Cost of

Patient Care

Facility Adjusted TotalI Estimated UCA2 Depreciation'sExpenses FY1980 Depreciation Contribution to

FY 1980 Total Expenses

"RMC, Camp Lejeune, NC $16,215,400 $999,636 6.2%

NRMC, Charleston, SC $18,644,182 768,701 4.1%

NRMC, Long Beach, CA t2l,151,371 $1,095,802 5.2%

NRMC, Bremerton, WA $12,449,242 t2,794,4203 22.2%

1 Total Expenses for FY 1980 were taken from References 29 and 30, less UCA

depreciation reported for FY 1980, plus the estimated annual depreciationexpenses that included all Real Property in the depreciable base.

2 Total Depreciation for year, Table 5.

3 Depreciation expense includes the new facility plus all equipment with adollar value equal to or greater than tl,000.

52

modernization and replacement equipment from the depreciable

base of a Naval Treatment Facility. It should be noted that

the $2,600,000 variance shown in Table 5 for NRMC Bremerton

is attributed to Bremerton being a new facility with the

majority of its equipment being new.

F. CAN DEPRECIATION'S CONTRIBUTION TO THE TOTAL COST OFPATIENT CARE BE ISOLATED IN ORDER THAT MANAGEMENTDECISIONS WILL NOT BE INFLUENCED BY SUNK COSTS?

Once depreciation expenses are allocated to the Final

Operating Expense accounts, that portion of patient care cost

attributable to depreciation can not be isolated. After

expense allocation, a reader of UCA summary data would need a

copy of a NRMC's expense assignment worksheet similar to

Table 12, (Appendix A) in order to isolate depreciation's

effect on health care cost.

If one accepts the idea that all past costs are irrelevant

and should not be included in future decision [Ref. 31], or if,

in the future, UCA includes all capital assets in the depre-

ciable base, then it is important to be able to see what effect

depreciation has on patient care cost. If Real Property is

included in UCA depreciation procedures, the change in de-

preciation expenses would be material. Depreciation would

then have a mater4 I affect on the total cost of patient care.

Taking Figure 8 as being representative of all Naval Medical

Facilities, depreciation's contribution to the total cost

of patient care ranges from 4.1% to 22.2%.

53

G. CONCLUSION

As stated in the opening paragraph of this chapter,

depreciation accounting is a recent occurrence within the

* military medical services, tracing its origins to the imple-

mentation of the Uniform Chart of Accounts. The purpose of

UCA depreciation is to account for the consumption of certain

long-lived fixed assets as an expense of providing medical

care and it is a part of a larger expense accounting system

that is designed to account for the total cost of patient

care.

As it is currently used in the UCA, depreciation is essen-

tially a composite rate of depreciation. In cases where fully

depreciated assets remain in service no further depreciation

is taken. Nor, are any adjustments made to recognize an

obvious change in an accounting estimate that would affect

the amount of depreciation charged to the operating expense

accounts such as a change in a medical facility's mix of

depreciable equipment that would either increase or decrease

their composite service life.

7 Two factors are the driving force behind the amount of

depreciation expense that will be allocated to the various

medical care accounts. They are: (1) only modernization or

replacement equipment with an acquisition cost equal to, or

greater than, $1,000 will be depreciated, and (2) equipment

will be depreciated over an eight year period. Both factors

can be challenged on the grounds that they tend to misrepresent

54

the amount of depreciation expense allocated to the operating

expense accounts. As shown by Table 5, including only

modernization and replacement equipment seriously understates

the amount of expenses generated by depreciation. The second

factor, eight year service life, can be questioned based on

random samples of equipment from seven NRMCs. These random

samples (Appendix B) raise questions as to the validity of

the eight-year composite service life. By accepting the pre-

* mise that equipment used at the various medical treatment

facilities comes from identical populations and that the

mean useful service life is eight years, one would expect to

see a series of random samples where the eight year composite

life would fall within a confidence interval for the sample

means. Appendix B indicates that while the samples were

random and drawn from similar populations the confidence inter-

vals for the mean useful service life had a lower limit of 10.5

and an upper limit of 12.5 years. The eight year composite

life falls well outside of the sampling interval and supports

the contention that the composite rate of depreciation should

be higher than eight years. Considering the availability of

data processing equipment, there is really no need to compute

a composite service life. Equipment can be depreciated on a

4 straight-line basis.

The UCA depreciation expense allocation does not account

for the fact that some clinical services are more equipment-

intensive than others. Disregarding this fact and accumulating

55

all depreciation expenses in a common cost pool and then

allocating the accumulated expenses on the basis of either an

occupied bed ratio or on a ratio of clinic visits penalized

those services that are labor-intensive and have a small invest-

ment in depreciable equipment. Labor intensive services are

penalized by assigning thm a disproportionate share of de-

preciation expense. According to Ferrara [Ref. 24] and the

Cost Accounting Standards Board [Ref. 25] the foregoing in-

equity can be corrected by charging the using cost center with

the depreciation expenses directly identified with its

operation. Only when a piece of equipment can not be identi-

fied with a particular cost center should it be recorded in a

common account and allocated to all cost centers on the basis

of either the occupied bed ratio or the ratio of clinic

visits.

Finally, unless some changes are made in the UCA account-

ing procedures, depreciation expenses for FY 1982 and beyond

will be overstated by an amount equal to 12.5% of the acquisi-

* tion cost of equipment with a unit cost that ranges between

*$1,000 to $2,999 purchased with Operating and Maintenance

funds.

56

17.-

V. RECOMMENDATIONS FOR CHANGES TO UCA DEPRECIATION

A. INTRODUCTION

Accepting the premise that the purpose of the Uniform

Chart of Accounts is to determine the total cost of patient

care and that depreciation is a legitimate cost of patient

care, there are several changes to the current UCA methodology

that are recommended which may improve the accuracy of the cost

figures generated by depreciation.

As noted earlier, UCA excludes from the depreciation pro-

cess a large segment of fixed assets used in the health care

delivery process. Nor does the process recognize deprecia-

tion attributable to specific cost centers. Additionally, the

process underestimates the useful life of equipment and once

the depreciation expenses are allocated to the final operating

expense accounts, the effect of depreciation on the total cost

of patient care can not be isolated unless a copy of the

expense assignment worksheet is available. Furthermore, a

recent development within Fiscal Year 1981 establishes the

ground work for double counting expenses associated with the

purchase of equipment with a unit cost that ranges from $1,000

to $2,999. All of the foregoing oversights, underestimations

and exclusions tend to inhibit the accuracy and usefulness of

the expenses generated by depreciation. However, with minor

adjustments the accuracy and usefulness of the generated

depreciation expenses can be enhanced.

57

Accounting for depreciation as an element of the cost of

health care delivery can be improved in five ways: (1) include

all capital assets that exceed the depreciation threshold in

the depreciation process, (2) allocate depreciation expenses

on a direct basis as well as indirectly, (3) depreciate capital

assets using a unit straight-line depreciation method, (4)

display depreciation expenses for the final operating expense

accounts in a format that shows what portion of the total

expenses are attributable to depreciation, (5) utilize adjust-

ing entries at the end of each UCA reporting period to avoid

double counting expenses associated with the purchase of

equipment in the $1,000 to $2,999 range.

B. RECOMMENDATIONS

1. Include All Capital Assets in the Depreciation Process

a. The accuracy of determining the value of capital

assets consumed in the process of providing health care can be

improved if all assets that exceed the depreciation threshold

are included in the depreciation process, irrespective of the

source of funds used to purchase the assets.

b. Depreciation can be accumulated in two accounts:

Real Property Account (to include buildings, land improvements,

utilities, elevators and alarm systems) and Equipment Account.

In addition to equipment with a value greater than $1,000,

the Equipment Account would include patient and office fur-

niture that exceeds the depreciation threshold value.

58

c. Once depreciation expenses are collected they

can be allocated on the basis of square footage of building

occupied in the case of real property, or on the basis of

°* either a ratio of occupied bed days or a ratio of ambulatory

care visits.

2. Use Two Methods of Allocating Depreciation to Eitherthe Inpatient Care Accounts or to the Ambulatory Care Accounts

a. Treat depreciation as either a direct or indirect

cost depending on its traceability to a particular cost center.

If the total use of a piece of equipment is traceable to a

particular cost center then the resulting depreciation should

be allocated to the using cost center. If. however, the

piece of equipment can not be easily identified with a par-

ticular cost center, then the depreciation should be treated

as an indirect cost and allocated to the final expense ac-

counts on the basis of either a ratio of occupied bed days

or a ratio of ambulatory care visits.

b. Treating depreciation as either a direct or in-

direct cost will more closely show the full cost of operating

a cost center. Dealing with depreciation as an indirect cost,

assignable only on a prorated basis, understates the cost of

operating equipment-intensive cost centers while at the same

time overstating the cost of those cost centers that are

labor-intensive. Whereas depreciation as a direct cost will

reduce this inequity and assign the cost of asset consumption

to the producing department.

59

- 4

I

c. Assign real property depreciation as an indirect

expense to the corresponding Real Property depreciation

account. Accumulated expenses can then be allocated on the

basis of square footage of building(s) occupied by the various

cost centers.

d. Allocating depreciation expenses utilizing the

foregoing methods will help determine the total amount of

resources used by a cost center, with the full depreciation

cost being the sum of its direct depreciation expenses plus

-" an equitable share of the indirect depreciation expenses. The

general principle being that each cost center should be charged

with the full amount of the cost that they cause. In essence,

cost centers will receive those depreciation expenses that can

be traced directly to them as well as an equitable share of the

depreciation expenses incurred jointly for two or more cost

centers.

3. Depreciate All Capital Assets Using a Unit Straight-line Method

a. In place of a composite rate of depreciation, all

capital assets can be depreciated using the unit straight-line

method. Depreciating each capital asset based on the individ-

ual useful service life eliminates the need to make several

4 strong assumptions associated with the composite rate of

depreciation. Primarily, the need to assume that the useful

life of the equipment is normally distributed throughout the

Spopulation and has a mean life expectancy of eight years,

60

4!

retired assets are replaced with assets having similar useful

lives and there will be no material change in the composition

of assets will be eliminated.

b. Additionally, the unit straight-line depreciation

method will more closely match the expected consumption of the

assets over time than will the current composite rate of

depreciation. In the event a fully depreciated asset is still

in use, the unit straight-line method will permit a Naval

medical facility to adjust the useful service life to reflect

the revision in useful service life as well as revision of an

accounting estimate. Both adjustments would be an improve-

ment over the current method which assumes all assets are

considered to be fully consumed after eight years.

c. Depreciating assets on a unit basis and adjusting

the service life for fully depreciated assets still in use

parallels the depreciation policy set forth by the Assistant

Secretary of Defense (Comptroller) Memorandum dated 6 November

1979 outlining the Department of Defense's depreciation policy.

The memorandum states in part that, "... the straight line

method of depreciation is appropriate when the expected con-

sumption of the asset is reasonably level over the useful life

of the asset ... Assets that are still in use will not be

fully depreciated ... the estimated life of an asset will be

reviewed and adjusted periodically to conform to current

plans for (the) asset's usage

61

of4. Display Depreciation in a Format that Shows the EffectofDepreciation on tne Total Operating Expenses

a. After depreciation has been allocated to the

final operating expense accounts a reader of summary data can

not tell what effect depreciation has on the total cost of

providing health care. This inability to separate a sunk cost

from the total cost of providing health care could result in

management decisions being influenced by an irrelevant cost.

In such areas as deciding on the desireability of providing a

medical service or purchasing the samie service from a civilian

* health care facility, or in comparing relative efficiencies

between Naval medical facilities, incorporating an irrelevant

cost in the comparative cost analysis could persuade manage-

ment that it was cheaper to purchase health care rather than

provide the service in-house, or decide that one Naval medical

facility was more efficient than another when in fact the

margin of difference in each case was attributable to a sunk

cost like depreciation.

b. Reporting depreciation as a separate column on

either the Medical Expense Performance Report or on other

reports such as the UCA Analysis of Inpatient Care and

Ambulatory Care (Refs. 29,30] and will decrease the chance

that management decisions will be influenced by a sunk cost.

Modification of the tJCA collecting and reporting system could

Klead to the production of a report similar to Table 9. Ta-

ble 10 is the format typically used to report medical expenses.

62

0.r4 t . l a0oc-W U.% ̂ %a t- 0 O-W -.0 0% t- CJ %a %

41 1O; ~ 0:C 0a

E4 b woi 14M- W0 r

4a lot0 U% t-CI 40 fn

0.x 4- 10 f-01-00 .4 0 -V t- cu

0- 1- m - . o ^1

f-C'4U.00u

0 d0

C4 I x t- -T 4 3...Lr 04 4Q

Ql~ to N, aW0i- i cii 4 cic T c

00.00. * 4 z 9(a en.J( fn0 f-440'0' UM cm- % i 40 4li4-) 02.i .- . .a a uo a .0ATtf C 0c t-- 0 d- 0 1. 4Oa 0 0

04 9 0 10 0 0 0 MC n -% m C.4 0 7 cu . 2*

r C

L I1, 1 m Co.4 M."'~ fn0 r03. S43. aX E- A X CU enM n M L 0 0 4) v.

o 0 4 401 J 1- -. u~'0'.4 -40 "4P. - %M 0 W %L- u 1 $.,a a .,m

r -4 41k to 0.m .em.~I-C a0 V 14 C g ,

at 1..O ca kd.4 Cld3l'(a "U' W u (o 4 0 1 4m y l- 441d4 r4 -4) a -

z Cll'.. 1.0 u. ~ .3..Z0

Q1 *C'4P0 4A MCl6u cu m M 1140 0

P. *:oas6 00 v:03.Qa. U m 4S-'m ZW A.O 9: 1^ A.D 0~.pa - - 2 0 4

(6 o . T 0% 400'x 40 L-416 " 40%0( 4% 000-

W 120 c fnco n L. a 4 40 4 63

2 ct-c ." t 00 0- 44

000 MEDICAL TXPENSE AND PERFORMANCE REPORT' ItE eacln a,,(hpI;

NAME AND ADDRESS OF FACIL IT Y IS.,ed0E J Cod., 0FACILITY CODE #111VO REPORT PE RIOD

REPORTING AUT64ORITY 109)1 MEDICAL REGION

Navy - Bureau of Medicine Unrd Surgery 13 Cumulative YTD

PART 1. DIRECT PATIENT CARE itIj.I.l h.Na,.,I.d ... ,..A....I .IIVb,., 1

INPTINTCAE ISOSTINS TOTAL FOXPENSES INCLUDING CLINICIAN SALARY (OCCUPIEDINPTIET CRE ISPSITONS CLINICIAN SALARY (F NSE BED DAYS

MEDICAL CARE i,o8*r $1,879,)440 $77,665 6.o84

SURGICAL CARE 1,717 2,2,A9,651 224,991 7,43T

D.STETRICA LJGYN ECOLOGICAL CARE 2,416 2 027,957 62,235 7,889

PEDIATRIC CARE 2,183 1,113,761 30,010 6,730

ORTHOPEDIC CARE ~ 765 810,276 14,135 4,271

PSYCHIATRIC CARE 366 437,6o8 55,8141 2,982

TOTAL 8t534 $8 518,693 1$464,877 35,393AMEBULATORY CARE TOTAL OUTPATIENT EXPENSES] OUTPATIENT VISITS INPATIENT VISITS

2

MEDICAL CARE $ 873,11 22.368 973

SURGICAL CARE 582,350 24,677 1,331

OESTETRICAL/GYNFCOLOGICAL CARE (8o,111l 61 ,1o,3 0

PEDIATRIC CARE 574,'785 33,91*7 0

ORTHOPEDIC CARE 336 830 12,076 1,636

PSYCHIATRIC/MENTAIL HEALTH4 CARE 210,161 10 179 84

FAMILY PRACTICE CARE 9149 439 40 308 0

PRIMARY MEDICAL CARE 2 117,034 83,477 0

EMERGENCY MEDICAL CARE 920 557 25 408 0

PLIGHT MEDICINE CARE - --

UNDERSEAS MEDICINE CARE -

TOTAL _________ $7,344,378 31.6,513 4,o24____

DENTAL CARE TDTAL EXPENSES WEIGHTED DENTAL POEUE WEIGHYFO DENTAL PROSTH4ETICPROCDUREWORK UNIT

DENTAL SERVICES $133,083 NA

DENTAL LABORATORIES 13.220 NA

TOTAL $146,303

Do FOlm f' SEE ATTACHED CAVEATSI OCT,, 2202 E

7XP ENSES INCLUDED IN INPATIFNT CARE ACCOUNTS

Table 10

NAVCOMP 2171 Functional Category/Expense Element* Report Reconciliation with UCA Expenses

64

I

Table 10

(Continued)

(000)

Expense from the NAVCOMP 2171 Report

Year-To-Date $18,780.81

+ Free Receipts 15.2

+ Depreciation 345.8

+ Borrowed Labor 26.9

Unauthorized Absence Labor (10.0)

- Loaned Labor (52.3)

- Direct Reimbursable Expenses (16.0)

Total Expenses Reported on this MEPR $19,090.4

SYear-to-Date Expenses Total was taken from the FunctionalCategory/Expense Report (NAVCOMP 2171) prepared by the Auth-orized Accounting Activity.

'46

:"- 65

It summarizes the health care delivery expenses and reconciles

the UCA expense with the Resource Management System's Function

Category/Expense Element Report (NAVCOMP 2171). Table 9

refines the Medical Expense and Performance Report and dis-

plays depreciation expense along side the appropriate patient

care account. The formats proposed in Tables 9 and 10 will

allow an analyst the opportunity to decide whether or not

depreciation was a relevant cost to be used in any comparative

cost analysis. Isolating depreciation from the total expense

of providing health care takes on added significance in the

event all capital assets are included in the depreciation

process. The added significance is attributable to the increase

in depreciation's contribution to the total cost of health care

brought about by incorporating all capital assets in the de-

preciation base.

5. Use Adjusting Entries at the End of Each ReportingPeriod to Avoid Double Counting Expenses

a. The amount of expenses allocated to a cost center

that comes from purchasing equipment with a unit price that

ranges between $1,000 and $2,999 can be subtracted from the

operating expenses for that cost center before the UCA step-

down allocation process begins. Making the adjusting entries

" has advantages over raising the depreciation threshold value

to $3,000. The chief advantages are: (1) data reported will

be consistent with prior year reports; (2) adjusting entries

* will eliminate the need to maintain two property accounting

66

.....

systems, one system to account for property in the $1,000 to

$2,999 range previously expensed and another system to account

for equipment in the same range that is subject to depreciation.

b. Additional support for making adjusting entries

comes from the Comptroller General's accounting guidelines for

* - Federal Agencies [Ref. 25] Raising the depreciation threshold

value to $3,000 would exceed the Comptroller General's guide-

lines for capitalization of fixed assets by a factor of ten

[Ref. 221 According to the Comptroller General's accounting

guidelines for Federal Agencies, "Fixed assets owned or

acquired by each agency shall be capitalized in its accounts

... it is appropriate to establish reasonable dollar minimums

as a basis for excluding certain property units from

capitalization. No minimum in excess of $300 should be

established ... " [Ref. 22] Considering that capitalized

assets form the foundation for depreciation accounting, it

* * ~ would appear that raising the depreciation threshold value

in the UCA to $3,000 would exceed the foregoing guidelines

established by Comptroller General by a much wider margin

than can be justified.

67

VI. SUMMARY AND CONCLUSION

A. SUMMARY

Depreciation, as a cost of providing health care, became

an integral part of a cost collection system that was imple-

mented in the Department of Defense in 1979. Known as the

Uniform Chart of Accounts (TJCA), the system's purpose was to

record, accumulate and report information regarding expenses

and workloads within the various military treatment facilities

as a means of determining the full cost of treating a patient.

Among the benefits expected to be gained from knowing the full

cost of patient care are enhanced cost awareness, cost-effec-

tiveness evaluation, improved decision-making and improved

cost comparability among the military treatment facilities as

well as with the civilian health sector.

Under the UCA, depreciation is used to allocate the cost

of the fixed assets used in the health care delivery process

in a systematic and rational manner. The type of depreciation

used is a composite straight-line method that assumes all

assets are either modernization or replacement equipment.

Specifically excluded from the UCA depreciation accounting

are new and expanded facilities, real property, War Readiness

Reserves and expenses associated with the support of such

special programs as vehicles, clinical investigations, drug

and alcohol abuse programs.

68

Once accumulated, depreciation expenses are allocated to

the final UCA expense accounts on the basis of a ratio of

occupied bed days for a particular inpatient account to the

total number of occupied bed days for the facility. The final

ambulatory care expense accounts receive their portion of the

depreciation expenses based on a ratio of ambulatory clinic

visits to the total number of a facility's ambulatory clinic

visits.

Several factors are taken for granted in computing deprecia-

tion under the UCA. They are: (1) the useful life of de-

preciable equipment is distributed normally throughout the

equipment population and have a mean life expectancy of eight

years, (2) replacement equipment have useful lives similar to

the equipment being taken out of service, (3) only moderniza-

tion and replacement equipment with a value greater than

$1,000 contributes to the expense of providing medical care

in a military treatment facility.

Depreciation use varies markedly between the Military

Health Service System and the Civilian Health Care System.

Essentially there are two major differences. First, the Mili-

tary Health Service System used a uniform method of deprecia-

tion that ensures all of the military facilities accumulate

4 and distribute depreciation expenses in a uniform manner,

whereas civilian hosvitals use a variety of depreciation

methods depending on the purpose for accumulating depreciation

expenses. For example, if a civilian hospital accumulates

69

depreciation for the purpose of generating cash flow, it will

probably choose an accelerated method of depreciation [Ref. 101.

However, if the civilian hospital's purpose is accumulating

depreciation in order to determine a contractual reimbursement

rate, it will choose straight-line depreciation [Ref. 28].

The second major difference is that the Military Health Service

System ignores a substantial portion of its depreciation

expenses by excluding real property and new or expanded

facilities in the depreciation process. While, on the other

hand, the civilian hospitals will include any item that has a

useful life greater than one year and whose cost exceeds the

dollar threshold established by law or administrative

regulation. An example of an administrative regulation that

establishes a depreciation threshold value is the $100 mini-

mum established by the California Health Facilities Commission's

Hospital Accounting and Reporting Manual, [Ref. 28].

While the UCA depreciation methodology systematically

accumulated and allocates the consumption of long-lived assets

L used in the health care delivery process, it has several draw-

backs that detract from its usefulness. Firstly, not all

capital assets are included in the depreciation process. A

substantial portion of a military treatment facility's de-

preciable assets are ignored, consequently understating the

full cost of patient care. Secondly, a composite rate of

depreciation is used that overstates the rate at which assets

are consumed by as much as 50% (Figure 13, Appendix B).

70

Thirdly, depreciation is inequitably allocated to labor-

intensive cost centers. As a result of not being able to

charge depreciation directly to a using cost center, the UCA

overstates expenses for the labor-intensive cost centers

while at the same time understating expenses for equipment-

intensive cost centers. Fourthly, depreciation's effect on

total operating expenses can not be isolated once depreciation

has been allocated to the final expense accounts. The in-

ability to isolate depreciation's effect on total operating

expenses can lead to management decisions being unduly

influenced by sunk costs. Finally, expenses associated with

the purchase of equipment in the $1,000 to $2,999 range are

being double counted in the expense allocation process. The

amount of the double counting will be approximately 12.5%

per year of the total dollar value of the equipment in the

$1,000 to $2,999 range that was put in service during the

year.

B. CONCLUSION

In determining the full cost of providing patient care,

it is essential that the cost of the capital assets used in

I. the health care delivery process be taken into consideration.

The Uniform Chart of Accounts' approach is a good starting

point in allocating the cost of capital assets to the final

operating expense accounts. However, with some adjustments

it is felt that additional benefits can be gained from the

71

I!

accumulation and subsequent allocation of depreciation

expenses. If the UCA will include all capital assets that

exceed the dollar threshold in the depreciation process,

irrespective of asset classification or source of funding,

and depreciate all capital assets on a unit straight-line

basis the resulting expenses will more closely equal the

total cost of health care delivery. Additionally, the mili-

tary treatment facilities depreciation expenses will more

closely parallel those of the civilian health care sector.

* Another adjustment that would benefit the cost collection

system would be to allocate depreciation as a direct expense

when a piece of equipment or a building can be identified

with a particular cost center. For those pieces of equipment

or buildings whose use is ubiquitous to the treatment facil-

ity, depreciation can be allocated on the basis of square

footage of building occupied, or on a ratio of either occupied

bed days or a ratio of ambulatory clinic visits. Double count-

ing of equipment expenses can be avoided if adjusting entries

are made to the NAVCOMP 2171, Functional Category/Expense

Element Report, to remove the value of equipment in the $1,000

to $2,999 range that was purchased during the reporting period.

Redesigning the Department of Defense Form 2202, Medical

Expense and Performance Report, to show the effect that

depreciation has on the cost of providing health care would

also be beneficial. Displaying depreciation as a separate

4 column on the Medical Expense and Performance Report similar

72

to the way that clinician salary expenses are currently

shown will not only show the effect depreciation has on the

total cost of patient care, but it will also help management

avoid being unduly influenced by a sunk cost when making a

cost-benefit analysis.

The foregoing adjustment will make depreciation accounting

more beneficial to the Uniform Chart of Accounts and make cost

comparisons between the military treatment facilities and theU civilian health sector more meaningful. There is however,

another area of UCA depreciation accounting that would benefit

from additional study. Such an area would be in the area of

automated property accounting. A researcher using the U. S.

Army Medical Department Property Accounting System as a

model may be able to adapt that system to the Navy Medical

Department or devise a system that, from a single data base,

would perform property accounting, automatically schedule bio-

medical equipment maintenance, and forecast future asset

requirements at a prospective replacement costs. A subfunction

of such a system would be an improved method of accumulating

depreciation expenses.

73

APPENDIX AUNIFORM CHART OF ACCOUNTS

FOR

FIXED MILITARY MEDICAL AND DENTAL TREATMENT FACILITIES

Throughout this study frequent reference will be made to

the use of depreciation as a summary account within the Uni-

form Chart of Accounts for Fixed Military Medical and Dental

Treatment Facilities (UCA). As an aid to understanding the

- effect that the UCA has on a military medical treatment

facility's expense collection and reporting, a brief descrip-

tion of the system is in order. Out of necessity the descrip-

tion of the Uniform Chart of Accounts will be brief. It will

deal only with those features of the UCA that the author feels

are essential to understanding the workings of the system.

Those readers desiring a more detailed description of the

Uniform Chart of Accounts are invited to read the Department

of Defense Instruction 6010.10M where the subject of thisLi? appendix is dealt with at great length.

A. DESCRIPTION1

The Uniform Chart of Accounts is an expense collection

and reporting system that allocates patient care cost to six

Unless otherwise indicated, the bulk of the informationabout the Uniform Chart of Accounts was extracted from Depart-ment of Defense Instruction 6010.10M [Ref. 4].

74

I'

functional accounts: Inpatient care, Ambulatory Care, Dental

Care, Ancillary Services, Support Services, and Special Pro-

grams. Each functional account is further divided into sum-

mary and subaccounts (Figure 2).

r- L

Stib :cont Sbacat (2 E ESubaccount

Figure 2

Two functional accounts, Support Services and Ancillary

Services are intermediate operating accounts. The other four

functional accounts are final expense accounts. Expenses col-

lected in intermediate accounts are allocated to the final

accounts via a step-down process that is based on either per-

formance factors or units of service measurements. The UCA is

arranged in a hierarchy in which the functional accounts appear

at the top and subaccounts are at the bottom.

Regardless of their position in the hierarchy, there are

four elements that are common to all accounts:

1. Function Element

Contains a description of the type of activity

characteristic of the account. The functional description

tells what type and level of services were provided, administra-

tive duties performed and such other data as required to clearly

75

distinguish between accounts in order to facilitate the rational

accumulation of cost data and work performance measurements.

2. Cost Element

Identifies the operating expenses incurred in operat-

ing and maintaining a discrete functional or organizational

subdivision (workcenter) of a military medical facility.

3. Performance Element

A measure of work produced by a work center, i.e.,

patient visit, occupied bed day, square footage of building

occupied, weighted procedure, etc.

4. Assignment Procedure

A method of cost allocation that distributes the

operating expenses of the two intermediate operating expense

accounts to the final operating expense accounts.

As a means of assisting in the understanding of the

UCA classification a brief description will be given as to

how functional accounts, summary accounts, and subaccounts

are classified.

a. Functional Accounts

(1) Inpatient Care account provides for the

examination, diagnosis, treatment, and disposition of inpatients.

Inpatients are those individuals who are admitted to a bed in

a medical treatment facility which has authorized or designated

beds for inpatient medical or dental treatment. This is an

account into which all operating expenses of the seven major

ri inpatient care summary accounts, medical Care, Surgical Care,

76

Obstetrical and Gynecological Care, Pediatric Care, Ortho-

pedic Care, Psychiatric Care, and Ophthalmology and Otorhino-

laryngology Care are summarized. This summarization repre-

sents the total cost of inpatient care. The performance

factor used to measure the work produced is the occupied bed

day.

(2) Ambulatory Care accounts provide for accumula-

tion of expenses associated with patient care relative to

professional advice and consultation, examination, diagnosis,

treatment and disposition of all categories of inpatients and

outpatients 2presenting themselves to the various ambulatory

clinics. The Ambulatory Care account is an account into

* which all of the operating expenses associated with the major

Ambulatory Care summary accounts are summarized (refer to page

81 for a listing of major ambulatory care accounts).

(3) Dental Care account provides for the sum-

marization of expenses associated with delivering comprehensive

dental care to armed forces members, certain former members

(subject to availability of space and capabilities of the

staff) and providing dependent dental care in certain well

defined circumstances. This is a final operating expense

account which shall include all of the operating expenses

* incurred in operating and maintaining Dental Centers and

2An outpatient is an individual receiving health care foran actual or potential disease or injury that does not require

4 admission to a medical treatment facility for inpatient care.

77

Clinics. There are no specific performance measures for this

functional account.

(4) Ancillary Services account accumulates the

summarized expenses associated with those activities that

participate in the care of patients principally by assisting

and augmenting the talents of the attending physician and

dentist in diagnosing and treating human ills. Generally,

ancillary services do not have primary responsibility for the

management of patients. Rather, patient services are provided

'. on order of the attending physician or dentist. The Ancillary

Service account shall be a summary account which will include

all of the operating expenses summarized in the major ancil-

*lary summary accounts listed on page 82 paragraph (4). It

should be noted that the order of accounts listed in paragraph

(d) is identical to the order of the step-down process used

to allocate expenses to the final operating expense accounts.

The performance factor used to measure workload are weighted

procedures [Ref. 4].

(5) Support Services account is provided to accumu-

late the expenses necessary to direct and support the mission

assigned to the medical treatment facility. With the excep-

tion of the Depreciation account, Support Services perform the

management and administrative functions of Ref. 12:

Command and Administrative Support Service

Personnel Support Service

Public Works

78

Material Service

Housekeeping and Janitorial Services

Biomedical Equipment Repair

Linen and Laundry Service

Inpatient Food Service

N Ambulatory Care Administration

This account will summarize all of the operating expenses of

the major support services, including depreciation, outlined

U above. It will be noted that when Depreciation is placed at

the top of the list of accounts outlined above, the listing

is identical to the order of step-down used during the assign-

ment of expenses to the final operating expense accounts.

There are no performance factors associated with this account

since the Support Services account is used only as a summary

account in which to totalize and report cost of the major

inclusive accounts.

(6) Special Programs account summarizes the expen-

ses of a military treatment facility which are incurred as a

result of performing those portions of its mission other than

direct patient care. This account is essential in order to

preclude these expenses from being charged to the facilityvs

direct patient care accounts. Paragraph 3a, page 7 contains

a listing of the primary summary accounts associated with

this functional account. Since this account exists only as a

repository of summarized expenses from the primary summary

accounts associated with Special Programs, there is no

associated performance factor.

79

b. Sunnary Accounts and Subaccounts

(1) Summary accounts are the second level of the

UCA hierarchy and services as a collection point for cost data.

As indicated by their names, summary accounts generally co-

incide with the services that are performed by the treatment

facility. The number of summary accounts in each functional

account ranges from one in Dental Care to eleven in Ambulatory

Care. Generally the summary accounts are self-explanatory

and the discussion about them in this paper will be limited

to listing the summary accounts under their general functional

heading. If a more detailed explanation is desired, the

reader is invited to read the applicable portions of the De-

partment of Defense Instruction 6010.10 (series).

(2) Subaccounts are the lowest level of accounts

in the UCA hierarchy. They are generally accounts that are

identifiable performance units [Ref. 12]. Subaccounts can be

established in any manner deemed appropriate by the facility

commander. These accounts are used to accumulate the initial

operating expenses associated with a workcenter. They are

used to meet diverse internal needs of the various military

medical treatment facilities. The only constraints on sub-

accounts are that they be assigned to the proper summary ac-

4# count during the reassignment and summarization process

(Ref. 12]. Subaccounts make the UCA sufficiently flexible

to allow the identification of expenses with an individual

unit or as a means of aggregating operating expenses into a

common pool for allocation to the proper summary accounts.

80

L-

- .c. Account Listings According to Function

The following accounts are listed in hierarchial

order. That is, the major heading is the function account,

followed by the summary account, and finally the subaccount

is listed. As a means of illustration and in the interest of

brevity, subaccounts will only be listed for the Inpatient

Care and Ambulatory Care summary account "Medical Care". A

more detailed listing of subaccounts is contained in the

Department of Defense Instruction 6010.10M, "Uniform Chart

of Accounts for Fixed Military Medical and Dental Treatment

Facilities". For example, the Internal Medicine subaccount

would be listed under the functional account Inpatient Care

and the summary account Medical Care:

(1) Inpatient Care (functional account)

(a) Medical Care (summary account)

Internal Medicine (subaccount)

Cardiology

Coronary Care Unit

Dermatology

*Endocrinology

Gastroenterology

Hematology

Intensive Care (Medical)

Nephrology

Neurology

*4 Oncology

81

• I ' | i i ' m ' ,i -- o"

Pulmonary/Upper Respiratory Disease

K Rheumatology

Medical Care Not Elsewhere Classified!ii

(b) Surgical Care

(c) Obstetrical and Gynecological Care

(d) Pediatric Care

(e) Orthopedic Care

(f) Psychiatric Care

(2) Ambulatory Care

(a) Emergency Medical Care

(b) Flight Medicine Care

(c) Family Practice Care

(d) Medical Care

Internal Medicine Clinic

Allergy Clinic

Cardiology Clinic

Dermatology Clinic

Diabetic Clinic

Endocrinology (metabolic) Clinic

Gastroenterology Clinic

Hematology Clinic

Hypertension Clinic

Nephrology Clinic

Neurology Clinic

Nutrition Clinic

Oncology Clinic

82

Pulmonary Disease Clinic

Rheumatology Clinic

Medical Clinics Not Elsewhere Classified

(e) Obstetrical and Gynecological Care

(f) Orthopedic Care

(g) Pediatric Care

(h) Primary Medical Care

(i) Psychiatric/Mental Health Care

(j) Surgical Care

(3) Dental Care

(a) Dental Service

(b) Type 3 Dental Prosthetic Laboratory

(c) Type 2 Dental Prosthetic Laboratory

(4) Ancillary Services

(a) Pharmacy

(b) Pathology

(c) Radiology

(d) Special Procedures Service

(e) Central Sterile Supply/Material Services

(f) Surgical Service

(g) Same Day Service

(h) Rehabilitative Services

(i) Nuclear Medicine

83

4-

(5) Support Services

(a) Depreciation

(b) Command and Administrative Support Services

(c) Personnel Support Services

(d) Public Works

(e) Material Services

(f) Housekeeping and Janitorial Service

(g) Biomedical Equipment Repair

(h) Linen and Laundry Service

(i) Inpatient Food Service

(j) Inpatient Affairs

(k) Ambulatory Care Administration

(6) Special Programs

(a) Specified Health Related Programs

(b) Public Health Service

(c) Health Care Services Support

(d) Military Unique Medical Activities

(e) Patient Movement and Military PatientAdministration

B. EXPENSE REASSIGNMENT PROCEDURE

Expenses incurred for support and ancillary services are

allocated to the final operating expense accounts by a cost

assignment methodology that contains five steps. They are:

Step 1: Non-personnel direct expenses and performance

data are assigned to the appropriate intermediate and final

operating expense accounts.

84

Step 2: Full-time equivalent man-months and salary

expenses are distributed to the intermediate and final operat-

-ing expenses.

Step 3: A pre-step down purification of cost within and

to medical treatment facility accounts' is done within this

step. Many of the support and ancillary services accounts

require that the expense charged to an account be prorated

* based on a unit of service, performance factor or other

criteria. This step-down can be done during Step 3 as a

purification procedure before step-down or by the allocation

process of Step 4. If the expense in question does not

include overhead expenses then Step 3 is used. If the cost

to be allocated includes overhead expenses then the cost

allocation procedures of Step 4 should be uspd. Purification

is the process of reassigning expenses from one operating

expense account to one or more other operating expense ac-

counts with the sole objective of recognizing the benefitting

function or activity for which the work was performed. Pu-

rification during Step 3 will not include any expenses re-

assigned from other accounts. Any reassignment of stepped-

down expenses will be done in Step 5.

Step 4: Expenses of the intermediate operating expense

t j accounts and cost pools are assigned through a step-down

process to the final operating expense accounts during this

step.

85

14

Step 5: Post-step-down purification of the final operat-

ing expense accounts is done during this step. Based on a

performance factor or unit of service, stepped-down expenses

assigned to final operating expense accounts can be reassigned

to another expense account. For example, inpatient or am-

bulatory expenses may be charged to a special program account

such as the Alcohol and Drug Abuse/Rehabilitation program

account. If there is a purification (reassignment) of expenses

from Ambulatory Care to a Special Program account there must

be a corresponding reduction in the number of visits reported

by the Ambulatory Care account. The number of occupied bed

days reported by the Inpatient Care accounts will not be af-

fected by any reassignment of expenses to or from Inpatient

Care accounts.

Table 11 is an example of a truncated expense assignment

worksheet that illustrates the step-down procedures used to

allocate expenses from the intermediate expense accounts to

the final accounts.

After the allocation procedures have been completed and

the intermediate expense accounts are closed, a Medical

Expense and Performance Report is submitted to the Office ofL

the Surgeon General. This report is submitted on a quarterly

basis. It consists of five parts, Parts I through IV provide

statistical data and Part V provides for a narrative summary.

86d.

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C. CONCLUSION

As stated at the beginning, this description of the Uni-

form Chart of Accounts is admittedly cursory in scope. How-

ever, it is hoped that the brief explanation was sufficient

to provide a basic understanding of the UCA to those familiar

with the Uniform Chart of Accounts for Military Medical Treat-

ment Facilities.

8

.°.-8

"a

APPENDIX B

STATISTICAL ANALYSIS OF THE UNIFORM CHART OF ACCOUNTS

COMPOSITE RATE OF DEPRECIATION

* A. INTRODUCTION

A basic assumption underlying the use of a composite life

of eight years is that the eight years is representative of

the average asset's useful life and that there have been no

material changes in either the composition of assets or in

the assets service lives [Ref. 91. As a test of the validity

of the eight-year assumption a series of 5 samples of size

30 were drawn from the equipment inventory lists from seven

*:- Naval Regional Medical Centers (NPMC). Samples from five of

the NRMCs were from the Equipment File List dated December

1979 on file at the Bureau of Medicine and Surgery, Navy

Department, Washington, DC. Samples for the NRMC, Long

Beach, CA were taken from that facility's Master Property

List as of 8 June 1980. NRMC, Camp Lejeune, NC samples were

drawn from the Item Category Report of equipment to be in-

cluded in the new facility under construction.

The tests that were done on the samples were computations

for means, standard deviations, confidence intervals, Runs

Test for Randomness, and a Kruskall-Walls One-Way Analysis of

Variance.

Except for NRMC Long Beach, CA each sample was drawn over

an interval where 30 items would be selected from the

89

4'°

facility's equipment list. NRMC Long Beach's samples were

drawn using a simple random sampling technique. Interval

sampling was selected as the primary means of obtaining

samples because of its simplicity and ease with which it could

be used with the format of the equipment list from which the

samples would be drawn. Interval sampling is the simplist

selection technique to use, and if used with care, it can

provide a reasonable degree of assurance that the sample had

been selected at random [Ref. 29].

B. MEAN, STANDARD DEVIATION, AND CONFIDENCE INTERVAL

Samples were drawn from the foregoing listings. A mean,

standard deviation and confidence interval was calculated for

each sample. Sample means were calculated as using the

formulas outlined in Wonnacott [Ref. 321.

1 nx z x.n- i=l 1

variance:

2 1 n (2S2 _ - E (X. - )n-i i=l J

Standard Deviation: S =J Variance

Confidence Interval: CI =X + t 025

4-i025

90

ff I- , -i-'- ' : ' , ... ... ... ... . . ;. ............ :. . .. ..... .. . . . .

where:

= estimated useful service life of each item

n =number of items in the sample (n =30)

0 2 5 =. Student's t variable for a confidenceinterval at 95%

Table 14 shows the results of the foregoing computations.

C. RUNS TEST FOR RANDOMNESS

As a means of verifying that the samples were selected at

* random a series of Runs Test for Randomness were performed.

Using the sample means a Runs Test for Randomness [Ref . 341

* were performed to determine if the samples were truly selected

at random. The null hypothesis H being that the samples were0

drawn at random. According to Wonnacott [Ref. 34], whenH0

is true the path of the observations crosses the sample median

frequently; pergo when His not true this happens much less

frequently. Accept H if and only if prob-value is greater0

than 5%.

In general there are 30 observations in each sample.

When His true, the distribution of the number of Runs (r)

is approximately normal with an expected mean value of:

n +1E(R) -7 Where n =the number of itemsin the sample

The expected Variance of the Runs Test is:

var~) =n(n-2) =(n-1)

.44

91

Using the normal approximation: Pr(r<UR)

can be determined [Ref. 34]. R

For example, take two samples one sample of 30 where the

equipment service lives crosses the median line a total of

6 times and a second sample where the observations crossed

the median line 15 times, the following prob-values would

be seen:

E(r) =30 + 1 =16

2

Var(r) = 30-1 = 7.25

4

Pr(6-16)

7.25

Pr(3.7)

Prob-Value = .0005 which indicates that the sample is not

random. On the other hand, in Sample Two with 15 runs:

Pr(15-16)

7.25

Pr(.37)

Prob-Value = .36 which strongly supports the assertio; that

the sample was selected at random. Table 12 is a tabulation

of the results of the Runs Test for Randomness. The results

of the Runs Test support the claim that the samples were

drawn at random.

92

TABLE 12

RUNS TEST FOR RANDOMNESS

NAVAL REGIONAL MEDICAL CENTER

Sample Bethesda Lejuene Charleston San Diego Pendleton Long Beach Oakland

1 .23 .36 .07 .13 .23 .36 .23

2 .14 .23 .23 .07 .03 .07 .03

3 .23 .36 .07 .36 .13 .24 .13

4 .23 .36 .36 .05 .23 .13 .23

5 .14 .36 .36 .36 .23 .07 .23

D. ONE-FACTOR ANALYSIS OF VARIANCE

A One-Factor Analysis of Variance was used to determine if

the samples for the individual NRMC's were drawn from the same

population. The answers sought were to the question, "Are the

sample means different because of differences in the underlying

population means? Or may the differences in sample means be

reasonably attributed to chance fluctuations?" Using the

methodology outlined by Wonnacott [Ref. 34] Table 13 shows

the calculations used to answer the foregoing questions.

E. KRUSKAL-WALLIS ONE-WAY ANALYSIS OF VARIANCE

The next step was to determine if the samples came from

identical populations with respect to the sample averages.

Accordingly, the Kruskall-Wallis One-Way Analysis of Variance

was selected as a useful device for testing the null hypothesis

that the samples came from identical populations [Ref. 33].

93

Table 13

Variance Analysis Results

Source of Variations Degrees of Variance F - RatioVariation Sum of Squares Freedom Mean Sum of Squares

(SS) (MSS)

Between Rows: P (\ --."explained" by TI ~ Xidifferene in , = ExplainedMeans Variance_Unexplained

VarianceWithin Rows:residual vari- 2 5-5ation resulting~ x~from chanceflucuations"unexplained"

*Total 0(i)X (71.%

Sample MeansBethesda Lejeune Charleston San Diego Pendleton Long Beach Oakland12.8 11.9 10.7 11.8 11.7 11.2 12.611.7 12.9 9.2 10.1 11.8 10.0 11.0

- 12.0 13.0 10.4 12.4 12.9 10.4 11.212.4 11.4 9.0 11.3 13.3 10.3 12.413.5 13.6 9.5 11.8 11.2 10.5 11.6

- 12.5 12.6 9.8 11.5 12.2 10.5 11.8 XiF-Ratio1.26 1.3 1.9 1.9 1.28 .43 1.35Prob-Value

.25 .25 .05PV< .1 .05CPVC.I0 .25 .25 .25Ho: UI = U2 = U3 = U4 = U5 Level of Significance is 5%

Decision: Reject H0 if and only if prob-value less than 5% or ifF-Ratio greater than 2.37

The F-Ratios in all cases were less than 2.37 and the prob-values were allgreater than 5%. Ho therefore cannot be rejected. The difference in samplemeans can be reasonably explained by chance fluctuations (Ref. 34).

94

. . . . -- -

Table 14Listing of Sample

Means, Standard Deviations and Confidence Intervals

NRMC, Bethesda, MdMean 12.8 11.7 12.0 12.4 13.5Standard Deviation: 3.6 2.4 3.4 4.8 3.8Confidence Interval:(11.5,14.1) (10.8,12.6) (10.7,13.3)(11.0,13.8)(11.1,14.9)Average CI: (11.7, 13.3)

NRMC, Camp Lejeune, NCMean 11.9 12.9 13.0 11.4 13.6Standard Deviation: 1.2 1.8 1.6 1.6 1.6Confidence Interval:(10.6,13.1) (11.1,14.6) (11.4,14.6)(9.8,13,0)(12.0,15.2)Average CI: (11.5, 13.5)

R MC, Charleston, SCMean 10.7 9.2 10.4 9.0 9.5Standard Deviation: 4.4 2.4 2.8 2.4 2.3Confidence Interval:(9.1,12.3) (8.3,10.1) 9.4,11.4) (9.8,13.0)(12.0,15.2)Average CI: (9.0, 10.6)

NRMC, San Diego, CAMean 11.8 10.1 12.4 11.3 11.8Standard Deviation: 1.4 0.9 1.4 1.2 1.3Confidence Interval:(10.4,13.2) (9.8,10.4) (11.9,12.9)(10.9,11.7)(11.3,12.3)Average CI: (10.6, 12.4)

NRMC, Camp Pendleton, CAMean 11.7 11.8 12.9 13.3 11.2Standard Deviation: 4.1 3.6 4.7 4.9 2.8Confidence Interval:(10.2,13.2) (10.5,13.1) (11.2,14.6)(11.5,15.1)(10.2,12.2)Average CI: (11.2, 13.1)

NRMC, Long Beach, CA* Mean 11.7 11.8 12.9 13.3 11.2

Standard Deviation: 1.3 1.3 1.1 1.4 1.5Confidence Interval:(9.9,12.5) (8.7,11.5) (9.3,11.5) 8.9,11.7)(9.0,12.0)Average CI: (10.0,11.0)

-RMC, Oakland, CAMean 12.6 11.0 11.2 12.4 11.6Standard Deviation: 3.3 3.0 3.9 3.5 3.0Confidence Interval:(11.4,13.8) (9.9,12.1) (9.8,12.6) (11.1,13.7)(10.5,12.7)Average CI: (11.0, 12.6)

95

i:

,,f ~ i 1 A ~ . .- . - -- - - - - - - -

AD-R127 823 DEPRECIATION ACCOUNTING IN THE UNIFORM CHRRT OF 2/2ACCOUNTS(U) NAVAL POSTGRADUATE SCHOOL MONTEREY CAC L GEORGE DEC 82

UNCLASSIFIED F/G 6/5 NL

IE E.'

1.0 Alto LIM,.

.M18

IjIJ -2 JIM8

MICRCOP REOUTO TESCAR

NAINA1 URA1f11NDRS-%-

In computing the Kruskal-Wallis Test, each sample average

was replaced by ranks. The smallest rank was replaced by 1,

the next smallest rank by 2, and the largest rank by N. Tied

averages were given the mean of the ranks for which tied.

The Kruskal-Wallis test determines whether the sums of ranks

are so disparate that they are not likely to have come from

samples drawn from identical populations [Ref. 33]. According

to Siegel (Ref. 331, it can be shown that if the null hypothesis

(Ho ) is true, and the samples are from identical populations,0

then the Kruskal-Wallis test statistic is distributed as a

Chi Square with degrees of freedom equal to (k-i) where k

equals the number of samples. Therefore, if the observed

value of the Kruskal-Wallis test statistic is less than the

value of Chi Square at the stated level of significance, the

H may be accepted at that level of significance.

Table 15 shows the results of the Kruskal-Wallis test.

Following Siegel's example, the null hypothesis that the

samples were drawn from identical populations can be accepted

at the 5% level of significance. The critical value for chi

square at 5% significance level with 34 degrees of freedom is

48.6 (Ref. 34]. The Kruskal-Wall.s test statistic is 23.34.

F. CONCLUSION

Based on the foregoing analysis of 35 random samples, it

is the author's contention that the samples came from identical

* populations. The analysis further supports the challenge

96

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u) 0 in

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that the average useful life of the equipment used at the

Naval Regional Medical Centers is higher than the composite

eight year service life used in the Uniform Chart of Accounts

to determine the annual depreciation expense to charge to

patient care.

- 9

98

LIST OF REFERENCES

1. Gibson, Robert M., National Health Expenditure, 1978,Health Care Financing Review, Summer 1979.

2. Rice, Donald B., Defense Resource Management Study andSupporting Papers, Feb. 1979.

3. Department of Defense, Military. Health Care Study,Dec. 1975.

4. Department of Defense Instruction 6010.10M, UniformChart of Accounts for Fixed Military Medical and DentalTreatment Facilities.

5. Grant, Eugene L. and Norton, Paul T., Depreciation* Revised, Ronald Press Company, 1955.

6. Miller, Martin A., GAAP Guide, Harcourt, Brace Jovanovich,

1979.

7. Seawell, L. Vann, Introduction to Hospital Accounting,

Revised, Hospital Financial Management Association,1977.

8. Meigs, Walter B. and others, Intermediate AccountingSolution Manual, 3rd Edition, McGraw-Hill Book Company,1974.

9. Meigs, Walter B. and others, Intermediate Accounting,3rd Edition, McGraw-Hill Book Company, 1974.

10. Berretta, Philip L., Regional Controller, Kaiser Founda-tion Health Plan Inc., Oakland, California. InterviewJuly 1980.

11. Kaiser Foundation Health Plan Inc., Standard Proceduresfor Property Accounting, 1976.

12. Hasselbald, Gary, Director of Finance, Community Hospitalof the Monterey Peninsula, Monterey, California. Inter-view May 1980.

13. Skull, Gary, Controller, Grace Hospital Inc., Morganton,North Carolina, Interview July 1981.

14. Bishop, Wil, Financial Director, California HospitalAssociation, Sacramento, California. Interview August1980.

99

, . . ..

15. Navy Department, Bureau of Medicine and Surgery, Equip-ment File List, Naval Regional Medical Center, Charleston,S. C., January 1980.

16. Naval Regional Medical Center, Camp Lejeune, N. C.,Item Category Report February, 1979.

17. Daniels, Jeri, Fiscal Officer, Naval Regional MedicalCenter, Long Beach, California. Interview August 1981.

18. Naval Regional Medical Center, Long Beach, California,Master Property List, June 1980.

19. Naval Regional Medical Center, Bremerton, Washington,Item Category Report, January 1980.

20. Fiscal Officer, Naval Regional Medical Center, Bremerton,Washington. Interview July 1981.

21. Seawell, L. Vann, Hospital Financial Accounting:Theory and Practice, Hospital Financial ManagementAssociation, 1975.

22. Department of the Navy, Bureau of Medicine and Surgery,Investment Equipment Instruction 4235.5G, 1979.

23. Department of the Navy, Bureau of Medicine and SurgeryMessage R052240Z Mar 80, Unclas N07043 Threshold Change

* -to Investment Equipment Costs.

24. Ferrara, William L., Responsibility Accounting - A BasicControl Concept: Readings in Cost Accounting, Budgetingand Control, South-Western Publishing Co., Cincinnati,4th Ed., 1973.

25. Cost Accounting Standards Board, Rules and Regulations:Standard 409 - Depreciation of Tangible Capital Assets,40FR4264, 1975.

26. Department of the Navy, Office of the ComptrollerFinancial Management of Resources, Publication NumberNAVSO P3006-I, 1980.

27. Comptroller General of the United States, AccountingPrinciples and Standards for Federal Agencies, Title 2,1978.

28. California Health Facilities Commission, HospitalAccounting and Reporting Manual, Jul 1978.

100

," . . *.

29. Department of the Navy, Bureau of Medicine and Surgery,Uniform Chart of Accounts Analysis of Inpatient Care,Report Number 20381-M02 Jul 1980.

30. Department of the Navy, Bureau of Medicine and Surgery,Uniform Chart of Accounts Analysis of Ambulatory Care,Report Number 20381-M04 Jul 1980.

31. Horngren, Charles T., Cost Accounting; A ManagerialEmphasis, Prentice-Hall Inc., 1972.

32. Sawyer, Lawrence B., The Practice of Modern InternalAuditing, Institute of Internal Auditors, 1973.

33. Siegel, Sidney, Nonparamedic Statistics for the Behav-ioral Sciences, McGraw-Hill Book Company, 1956.

34. Wonnacott, Thomas H. and Wonnacott, Ronald J., Intro-ductory Statistics, 3rd Ed., John Wiley and Sons, 1977.

101

INITIAL DISTRIBUTION LIST

No. Copies

1. Defense Technical Information Center 2Cameron StationAlexandria, VA 22314

2. Defense Logistics Studies Information ExchangeU. S. Army Logistics Management CenterFort Lee, VA 23801

3. Library, Code 0142 2Naval Postgraduate SchoolMonterey, CA 93940

4. Assoc. Professor Shu S. Liao, Code 54LcDepartment of Administrative SciencesNaval Postgraduate SchoolMonterey, CA 93940

5. Assoc. Professor David R. Whipple, Code 54WpDepartment of Administrative SciencesNaval Postgraduate SchoolMonterey, CA 93940

6. Department Chairman, Code 54Js 1Department of Administrative SciencesNaval Postgraduate SchoolMonterey, CA 93940

7. LT Charles L. George, MSC, USN 3Box 95Naval Regional Medical CenterCharleston, SC 29408

102

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